Taking out a loan? Here are 4 tips to avoid being trapped by debt
Applying for a home loan can be tricky and complicated, more so if it’s your first time going through the process. How can you avoid falling into a debt trap?
The property boom and rock-bottom rates in Australia have lured people to take on loans. However, the latest data from the Australian Prudential Regulation Authority (APRA) shows that about a quarter of new mortgages are considered risky.
According to APRA’s quarterly Authorised Deposit-taking Institution (ADI) property exposure report for September 2021, “23.8 per cent of new lending in the quarter had a debt-to-income ratio of six times or more, in dollar terms”.
Just a year earlier, only 16.3 per cent of new loans had debt-to-income ratios of this level. APRA warns that debt-to-income ratios of six and over are considered risky.
Sally Tindall, research director at RateCity.com.au, said: “Australians are increasingly taking on eye-watering levels of debt, compared to what they earn, to get into an overheated property market.”
And because of this, banks have been required by APRA to stress test mortgage applications to ensure that they can withstand rate increases of up to 3 per cent effective 1 November.
Labelling increasing debt-to-income figures as “concerning”, Ms Tindall does hope that APRA’s latest stress test requirement, along with recent fixed rate rises “could be enough to placate the market, at least for the next couple of months”.
“APRA is keeping a very close eye on both the rise in investor lending and burgeoning debt-to-income ratios, however, at this stage, we expect they’ll take the summer to take stock without implementing further changes,” she concluded.
Here are four tips for taking out a loan while avoiding the debt trap:
1. Focus on the total debt amount
Looking at just the monthly mortgage repayments can sometimes deceive a borrower into thinking that the loan is easy on the budget. But at times, loans with low monthly repayments have bigger debt amounts, higher lenders mortgage insurance (LMI), or higher interest.
2. Don’t overstretch your budget; consider alternatives when you find yourself priced out
Low-income borrowers may find it more difficult to obtain a home loan, but it is not impossible. Here are the options you can consider:
- Sign a contract with a partner/investor.
- Make use of a guarantor.
- Keep your expenses in check by applying for a less expensive home.
3. Take into account future rate hikes
Ms Tindall has lamented that although Australians may now borrow more money from the bank due to historically low interest rates, what some borrowers may have not foreseen is when interest rates begin to rise, those who have taken on high levels of debt may find themselves at a loss when managing their monthly budget.
4. Make an effort to get ahead on your loan.
Trying to get ahead of your loan when you have extra funds can help decrease your debt amount. As a result, you’ll be able to pay off your loan before interest rates climb.
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