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Borrowers should avoid complacency after the latest rate cut.

Mortgage holders may have breathed a collective sigh of relief this week when the Reserve Bank of Australia again cut official interest rates. But it’s essential to keep an eagle eye on your personal borrowing capacity and ability to manage debt. The economic headwinds that lie ahead are unclear and there’s no room for complacency.

In fact, the 0.25-basis-point rate cut is an opportunity to review the state of your borrowings and debt repayment schedule. More than ever, you should avoid the following common borrowing mistakes:

Blowing out credit card limits

Credit card limits can shrink your borrowing capacity. Even if you’ve never used that $24,000 or $38,000 limit a card provider has extended, some lenders view the amount as your total liability. A smart approach is to set limits low and use debit cards.

A strategy that works well for some couples is to put credit cards in the low-income-earning partner’s name. It’s one way to have the convenience of a credit card without creating a liability.

Stretching beyond your means

Don’t blindly follow a lender’s borrowing calculations. Only you know the actual state of your household finances and what kind of safety buffer you need to sleep at night. When lenders say they will lend you X amount based on your income, always factor in what could happen if your circumstances change and consider borrowing a lesser amount.

The investors and home owners who get into financial strife are almost always those who’ve borrowed to the hilt because a bank or finance company allowed them to do so.

Not preparing a budget

Although it is important to borrow within your personal means, there’s nothing to stop you trying to increase your borrowing capacity. The caveat is that you need to be confident you will be able to comfortably service the new level of debt. To make the most of your borrowing capacity, prepare an accurate budget that sets out income and expenses, to show that you can afford to take on additional debt.

A budget document showing your cash-flow position isn’t just a great planning tool for you. It could influence a lender to increase the amount of the loan it is prepared to offer.

Opting for short-term loans

You may think it’s prudent to sign a short-term lease for a new car to pay it off as quickly as possible. Bear in mind, though, that short-term loans come with big monthly repayments and this will eat into your borrowing limits for housing purchases.

Where possible, negotiate the longest loan term you can. This will keep your minimum repayments low on existing loans. Still, you want the flexibility to pay off any loan faster than you have to. If you apply for a fixed-rate loan, consider splitting borrowings in two. When half the amount is fixed and the rest is on a variable rate, you have more flexibility.

Not knowing the funding source

Knowing the source of a lender’s wholesale funds may help you avoid paying mortgage insurance. ”Balance sheet” lenders, such as banks and credit unions, generally fund their mortgage books through their deposit base – they take a percentage of the money held on deposit and lend it out as mortgages. Another source of funding is through the money markets – lenders borrow money at low rates and re-lend it at a higher rate.

Funding by securitisation is a third way lenders get wholesale funds. Tread warily, though. Securitised lenders aggregate a large number of individual mortgages and resell them back to wholesale markets. They often insist all their mortgages be insured, which pushes up borrowing costs.


Posted by Chris Tolhurst – The Age on 6th October, 2012