Money's Costlier, So Is Failure To Plan

THE SUNDAY AGE

Saturday August 20, 1994

Neil McKissock

ONE thing is certain about last week's rise in official interest rates: it will make borrowing money for any reason more expensive for everyone.

It is certain to flow through to mortgage rates, interest rates on personal loans and maybe credit cards. The possibility of a sharp rise in interest rates is one of the risks you face if your day-to-day life is structured around debt. Many people have been attracted by bank advertisements encouraging them to merge their debts into their variable rate home loans - or borrow money for such luxuries as a holiday or a boat.

While the attractions have been the prospect of borrowing at a lower rate than is charged on credit cards and personal loans and then spreading the extra debt over a longer period - which makes it look more affordable - the fact of life is you will always end up paying more in total interest. This total interest will now be even higher with any rise in variable home loan rates.

A good financial planner will never encourage his or her clients to borrow money to spend on such luxuries as an expensive holiday. While occasional debt on a credit card never hurt anyone, giving yourself an immediate burden of several thousand dollars that lingers long after you have enjoyed the spending does not make good financial sense.

This sort of debt must be distinguished from any strategy of borrowing money to invest. Properly planned investment borrowing to finance assets can build your wealth.

Borrowing money for luxuries makes you poor rather than rich. For one, it immediately adds the cost of the interest to that of your holiday or other luxury.

There is really only one smart way to enjoy such spending without suffering afterwards: save for it in advance. This is one of the most basic bits of financial advice everyone should consider. Developing a savings habit through modern savings plans with their competitive returns is the only way to counter the unnecessary extra expense of borrowing money for luxury items.

For most people, the art of saving must be learnt: it begins with the realisation that debt is often something we can control. If you can repay a loan in a disciplined way - which most people do when they repay a mortgage - you can use the same approach to save in a disciplined way.

The benefits of saving are numerous. It can be for special purpose or just general. You can save, for instance, to create a fund to cope with an unexpected emergency.

You can save to build up small capital amounts that can then be used to speed up your mortgage repayment. Each repayment consists partly of principal repayment and partly of interest. In the early stages of a loan, the portion of interest is higher than the principal.

When you make a lump sum payment on your mortgage beyond your normal repayment, this immediately comes off the principal you owe. The next time interest is calculated on the loan, less interest is charged.

That's how you save interest and reduce the term of your mortgage.

Lump sum savings can be used to make long-term investments, such as buying a parcel of shares in a quality company or for a deposit on a property. Savings plans with a growth focus are also vehicles for an education fund for children. Or even a plan to get a new family started.

Of course, you can also use the money to pay outright for a holiday or any luxury. Remember, offering to pay for anything in cash will often give you the clout to ask for a discount.

The savings habit can be extremely useful when two people who are family partners are both working. That's an ideal time to save because quite often your discretionary income will be high.

A range of savings plans is available from respected financial institutions. They can be started with any amount from zero to $1000 and have minimum monthly contributions of $100 upwards.

The returns they offer depend on the investment strategy of the plan - some focus on growth, others have a balanced approach, yet others centre on income and maximising security.

Where income is not required, any income distribution under a plan can generally be reinvested in extra units.

This allows your total plan to grow. Returns between nine and 15 per cent a year over the past three years have been achieved with well- managed plans.

This should act as an incentive to put a regular amount away but, if you don't think you have this discipline because each week you spend every dollar in your pocket or purse, you can arrange a direct debit from your cheque account or wages. That way you'll automatically spend less and save more.

Neil McKissock, is a financial planner with Godfrey Weston Ltd, a licensed securities dealer.