Prepare for credit crunch

The days of cheap, fast money are coming to an end, so get ready now for the squeeze

RECORD low official interest rates are set to continue until at least early next year, job growth continues to be strong, inflation low and economic growth solid.

Economically it all looks pretty good at the moment. But don’t be fooled: A good oldfashioned credit squeeze has been forming and it looks like it is building momentum.

While money will stay historically cheap, it will become harder to get.

The days of cheap, fast money are ending quickly. This new money world will come as a shock to many, especially as it gets more serious. It’s all because of a range of factors, including:

REGULATORS are clamping down on bank-lending practices, demanding more conservative criteria because of their high exposure to home lending.

THE fall in property prices is forcing banks to reassess the security needed to support loans.

BANK funding costs are rising as interest rates in overseas markets are increasing.

BANKS need to raise more capital to support their loan books.

All this means it will be harder for Australians to borrow. We’ve already seen the start of the ripple effect, with banks demanding higher deposits from home loan borrowers and foreign investors forced to pay higher borrowing costs.

The next major ripple effect, which is expected in the next couple of weeks, will be thousands of interest-only borrowers being forced into principal and interest loans. It will come as a shock for many borrowers that the bank can change their loan (which they can) and it will mean higher repayments.

So here’s our guide to protecting yourself against a credit squeeze.

STRESS TEST YOUR LOANS

All banks stress test their loan book for a change in the economy, interest rates or the housing market.

You should follow suit and be stress testing your personal finances in the same way.

That means having a realistic household budget for the next year, and also having a worstcase scenario budget if things go sour.

Have an action plan of what needs to be done in a worst-case scenario. Better to be prepared for global shocks than to be caught unawares.

Start understanding all the loans you have and what assets they’re secured against. For example, compare the value of your mortgage against the value of your home. In this era of falling values in the major property markets, if the equity in your house is less than 1020 per cent, your financial institution will be watching closely.

So try to use spare cash to get ahead on repayments to show you have everything under control.

If you have an interest-only home loan, use the repayment calculator on your bank’s website to see how much repayments will change if you are forced into a principal and interest loan. Slot the new monthly repayment schedule into the household budget to make sure it can be covered … or make adjustments to cope. Consider switching to a fixedrate, fixed-term loan if that is more advantageous.

If things look really bad, consider selling assets (shares and investment property) to raise cash to pay down debt. But make sure you get professional advice first.

With unsecured credit, such as personal loans and credit cards, keep on top of repayments and show good payment habits.

These are all signals banks will be looking at when assessing the credit worthiness of their customers.

PROTECT EXISTING LINES OF CREDIT

Access to credit is going to get a lot harder as banks cope with the uncertainty caused from the tightening of regulations and the increasing costs of funding.

At a recent function, the boss of one of our big four banks told their top clients: “If you’ve got money to put on deposit, we are going to love you, but if you want a loan, we don’t want to know you.”

As lending criteria tightens, capital requirements rise and overseas funding becomes more expensive, banks won’t have a lot of spare cash to lend.

Therefore if you have an overdraft or line of credit, keep it under control but don’t get rid of it, because that may be the only credit you get.

We’re hearing lots of stories of people who previously had no trouble getting loans, having their applications rejected.

BE NICE TO YOUR BANKER

This is an extension of the last tip because, from now on, bankers will not be hosing money at old or new clients like they have been doing over the past 10 years. They are under instructions to go through each client and satisfy the bank’s credit department of their financial soundness.

If you are expecting any financial glitches in the next couple of months, forewarn the bank and provide a plan of how you intend to get back on track.

This is particularly critical if you own a small business. That means it’s up to you to keep your bank manager informed as to how the business is going.

Do whatever you can to make sure they have confidence in you. You’ve got to have your bank manager on your side.