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House-hold debt may be higher now than during GFC - expert

Newshub logoNewshub 6/08/2019 Priscilla Dickinson
a close up of a device: Credit cards can lead to bad debt if not repaid. © Getty Credit cards can lead to bad debt if not repaid.

Although that buzzword 'mindfulness' is about paying attention in the moment, an expert is warning that from a financial perspective, it's also wise to keep one eye on the future.

An environment of lower interest rates can entice people to borrow more and ultimately, take on too much debt, said Sam Stubbs, managing director of Simplicity, while appearing on The AM Show on Tuesday. 

Borrowing money to put into an appreciating asset can be a good thing, however taking on too much bad debt can lead to overspending, says Stubbs.  The trap of the 'fake rich' is becoming more common.

"As countries get richer and the economies get a little more stable, and most importantly, as interest rates go down, you tend to see people borrowing more and more money," Stubbs explains.  

New Zealanders' house-hold debt is around the middle of the pack globally and is on the rise.  In a society filled with the temptation to borrow and spend, it can be relatively easy to take on too much debt.  But is all debt a problem  - and how much should we take on?

Good and bad debt

Taking on good debt, such as a house, means you're actually investing in something that appreciates in value. Bad debt, or spending to consume (credit cards, payday loans and hire purchase) tends to incur high interest rates, causing people to get caught in a debt trap. 

Is our house-hold debt higher now than during the Global Financial Crisis (circa 2007-2009)? Stubbs believes it is, because as interest rates come down, borrowing tends to increase.

"The more confidence you have in the future, the more confidence you have to borrow.  What you're going to get is a whole generation of Kiwis now who are much more comfortable with debt and most importantly, much more comfortable with housing debt," he says. 

"If you see mortgage rates go down, people aren't going to be thinking about how long it's going to take to buy the house and repay the money they borrowed.  They're just thinking 'how much does it cost me, week-by-week, to pay the interest on that mortgage'," Stubbs said.

Referring to countries where borrowing is around 2 percent for up to 50 years, Stubbs says this environment encourages people to buy a house because the cost of servicing the debt is lower than the rent.  The danger is that the mortgage may never be repaid and its possible that New Zealand could get there too.

"That's why building low-cost housing is so important. "You need to give people the opportunity to get into that situation, as opposed to paying high rents for the rest of their life."

Is there a limit on borrowing relative to income?  

 

Although there are variables such as interest rates and the type of investment, there needs to be an allowance for living costs.

 "The rule of thumb is you should try not to spend more than 30 percent of your income on servicing your housing costs," Stubbs said.

He advised people to think sensibly about where funding for discretionary spending (e.g. upgrading the car, TV and off-shore holidays), is coming out of savings or borrowing.  

"If you're borrowing to fund that, buy and large, you'll be paying a higher interest rate."

While a mortgage can be set up to accommodate wider spending (e.g. through a revolving credit facility), people should exercise caution.

In a consumerist society where we want things now - and don't have to wait - do we need most of the stuff we buy and does it make us happy?  

From a monetary perspective, the optimal happiness point has been widely cited.  While there's some debate about what the magic 'happiness figure' is, Stubbs said it is around a joint income of $85,000.  

"Money's critical to a point.  "More things don't equal happiness," Stubbs said.  

A guide to improving your household spending can be found in our seven simple money hacks to help you finally stick to a budget.

Information on Simplicity's low-cost KiwiSaver and investment fund options is available on the Simplicity website.

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