The City watchdog says now is the time to check that you can cope with an economic shock, writes Philip Scott
The City watchdog last week urged all households to “stress-test” their finances to check they could cope with a weaker economy and higher interest rates.
In its annual Financial Risk Outlook, the Financial Services Authority (FSA), said many consumers had become used to ever-rising house prices and low interest rates and were not prepared for a financial shock, especially as debt is at record levels.
Average debt has soared to an all-time peak of nearly 152 per cent of disposable income, almost double its 1980s level.
The Bank of England has already raised rates three times since August, from 4.5 per cent to 5.25 per cent — their highest level for almost six years — and analysts say further hikes to 6 per cent cannot be ruled out. At the same time, consumers face high utility bills and a heavier tax burden.
About 1m adults are already falling behind with debt repayments and a further 2m struggle constantly, said the FSA. People in rented accommodation are more likely to be in distress, while the overwhelming majority of people with mortgages are coping — but this could change.
The watchdog found that 40 per cent of people would struggle if loan repayments went up by 20 per cent — which is troubling given that mortgage costs have already risen 17 per cent since August.
There are already signs the property market is slowing after the recent rate hikes. In January, house prices rose 0.3%, the slowest pace for eight months, according to Nationwide.
Data last week revealed court orders to repossesses property are 22 per cent higher than last year, while individual voluntary arrangements, an alternative to bankruptcy, have surged 111 per cent.
Here we offer advice on stress-testing your household finances.
Mortgages
In its risk outlook, the FSA asked consumers if they could cope with a 10 per cent and 20 per cent increase in their mortgage repayments, and you should do the same.
Someone with a £200,000 interest-only home loan that tracks Bank rate has seen monthly repayments rise from £750 in August to £875 — a 17 per cent rise. They could go to £917 if Bank rate hits 5.5 per cent and £958 at 5.75 per cent — a 9 per cent increase. Online calculators can help you work out how much you would pay at different rates. Try lcplc.co.uk or charcololine.co.uk.
If you could not cope with a rise in repayments, consider a fixed rate. Stroud & Swindon building society has the best deal at 4.89 per cent for two years. The repayments on a £200,000 loan would be £815. There is an arrangement fee of £1,499.
BM Solutions has a two-year tracker at 4.74 per cent with an arrangement fee of £1,499. While your repayments would start off cheaper, Bank rate would need to rise only once more before you would be better off with a fix.
Michael Woodfine from Hampshire is in the process of switching his mortgage to a 4.94 per cent, two-year fixed deal with Nationwide. He said: “Our mortgage is our main outgoing and with a fixed deal you have the security of knowing how much you will be paying every month.”
The FSA is also worried that thousands of people are relying on equity in their homes for school fees or retirement income, but could be disappointed if prices stagnate. If you do borrow against your home, make sure you leave a 10 per cent buffer.
Savings and investments
More than a quarter of households are vulnerable to an “income shock” because they have no savings to tide them over if the main earner was unable to work, according to the FSA.
Advisers recommend you have at least three months’ salary in an instant-access account to tide you over. The best account is Icesave, which pays 5.7 per cent from £250.
Households should also look at their investment portfolio following three-and a-half years of unprecedented growth, when most assets, including property, equities and commodities, have performed well. Such a benign scenario is unlikely to last, according to the FSA.
Justin Modray of Bestinvest, an adviser, said: “It is important to have a mixture of investments including cash and bonds as well as property, equities and commodities so your losses will not be too heavy if one of them dives.”
Pensions
Nearly 12m workers do not make any contribution to a private pension. Tom McPhail of Hargreaves Lansdown, an adviser, said: “More immediate needs are taking priority over saving for retirement, such as getting on the property ladder, paying the mortgage and coping with increasing bills.
“People need to get into a discipline of saving. If your employer offers a pension take it; if it does not, start your own personal pension and review it regularly.”
Someone in their twenties should be saving at least 10 per cent of their earnings every year, including their employer’s contributions, rising to 15 per cent in their thirties and forties.
Hargreaves Lansdown charges no annual fee or set-up cost for its self-invested personal pension (Sipp). If you would prefer a more basic stakeholder pension, McPhail recommends Scottish Widows, which charges 1per cent or less a year through a broker.
Insurance
It is possible to take out insurance to protect your household finances, but think carefully about what you need before succumbing to the hard sell. First check with your firm what you get through your employment package.
Most companies will protect your income for several months if you are unable to work due to sickness or an accident, and you may also get a death benefit of four times salary through your pension. If you do not get these perks, consider an income- protection and a life-assurance policy.
Source: Times Online
Please post any news stories about IVAs here:
http://www.iva.co.uk/forum/default.asp?CAT_ID=5
See my Blog:
http://ivanews.blogs.iva.co.uk
