The pace of the damage being caused by the coronavirus in Australia has been difficult for everyone to keep up with.
There have been dramatic lockdowns of entire industries putting thousands out of work and many have been left with a genuine worry about how they will pay the rent and keep food on the table in the coming months as Australia almost certainly enters a deep recession.
The crisis is all the more difficult to predict because nobody knows how long it will continue and when the health and wealth clouds will begin to lift.
Need for great care in accepting some assistance “offers’’
However, amidst the many sound announcements that have been made offering income support and new Government payments, there are a few very real wealth traps that people should avoid falling into if there is any alternative.
At the very least they need to calculate the total cost before committing to any changes.
One of those potential traps is the offer by most of the big banks and financial institutions to implement a repayment “holiday’’ on business or home loans to help people get over a lack of income from the shutdowns.
Another alternative to this is automatically reducing mortgage repayments to the minimum rather than leaving them at a higher rate that most likely applied when interest rates were higher.
Another really radical one is the chance to withdraw up to $20,000 over two financial years from superannuation to similarly get some much-needed cash at a time of crisis.
I don’t want to suggest that any of these offers have been produced for the wrong motives or could not be very helpful for some people.
Indeed, one of the reasons bank shares have been hammered is that these sort of offers increase the risk of the banks suffering even higher bad debts.
The offers should, however, both come with a significant asterisk that reads: Accepting this offer could significantly harm your wealth in the long term.
A repayment holiday could leave long-term headache
One thing that should be understood about the repayment “holidays” is that these are not the sort of carefree, sit on the beach type holidays.
Rather they are more the “we love having you as an interest paying customer so much that we would like to extend our relationship with you for many more years’’ type of offer.
If you accept a repayment holiday, make sure to do the maths about how much accepting the offer will really cost you in the long term and compare that with alternatives such as using existing short-term credit lines, cutting costs or other means to fund the shortfall.
Do not make the mistake of thinking the repayment “holiday’’ is some sort of benevolent gift that the bank is making to help you out of a tough spot.
Interest calculations don’t take a holiday
One thing that is not taking a “holiday’’ is the interest rate calculation which continues to add up along with the missed payments during the holiday and will then be added on as a lump sum to the loan when repayments begin again.
So, the loan ends up bigger than it was at the start of the holiday which means the repayments will need to rise above where they were before the holiday began or the term of the loan will need to be increased.
Neither alternative is particularly palatable but the costs of lengthening the loan in particular could add up significantly, so make sure you work them all out to make sure taking this sort of “holiday’’ is as relaxing as it sounds.
Lower repayments come with a big catch
The automatic reduction of repayments is similarly a potential wealth trap, particularly at a time when many Australians have successfully maintained higher repayments for many years as interest rates have fallen – effectively saving a large amount of interest and getting “ahead’’ on the loan, which is a fantastic position to be in when a nasty external shock such as coronavirus comes along.
In this case, reverting to a much lower monthly payment might seem fantastic in the short term but it will leave you paying off that loan for many more years than would have been the case if repayments had been maintained.
Many people who take out loans are astonished when they actually work out the extra costs they will be up for by using one of the many online compound interest calculators that are available.
In this case, compound interest is really working against you and maintaining current higher repayments will usually save a serious amount of time and money over the loan term.
One alternative when the loan is effectively “ahead’’ is to use these extra repayments you have already made as a buffer to temporarily reduce the loan repayments before resuming a higher repayment rate in the future that will ensure the business or individual is once again “ahead’’ of the planned loan repayments.
Early access to superannuation can be an expensive option
The other really significant offer that has been made is to provide Australians with the chance to early access to $20,000 from their superannuation accounts over the current and next financial year.
The first thing that should be said about this is that now is precisely the wrong time to be withdrawing any money from superannuation.
As we are all painfully aware, Australian and international shares have taken a massive bath since February and any withdrawals from super accounts at this time will result in crystallising a loss at the worst possible time.
Selling shares at the wrong time is costly
Many superannuation accounts will be down by 20%, 30% or even more thanks to the extreme share market falls suffered over the past few weeks.
Over time those losses can be expected to recover and if the worker is young and many years from retirement, they could be looking at getting five or ten times what they are withdrawing now if they stay the course and keep the money within superannuation.
In this case, as opposed to loans, compound interest is working in their favour and can be expected to magnify and multiply gains over many years.
The very reason that superannuation is so effective at ensuring retirement incomes is that it is unable to be accessed except in very particular circumstances.
It could be argued that the coronavirus pandemic is an exceptional circumstance but still, individuals should crunch the numbers very carefully rather than just accepting at face value that withdrawing superannuation in a bear market is a good idea.
Again, it is worth exploring all of the alternatives including the government income support payments that are on offer rather than simply jumping on a superannuation withdrawal.
None of this is to suggest that restructuring loans or withdrawing superannuation will always be a bad idea – just to add a note of caution that in extraordinary times, it is not always a good idea to automatically grab every lifeline that is thrown in your direction.
Like all big decisions you need to get a piece of paper and a pen out and really calculate the costs carefully so that you can make a decision that is least harmful to your long-term wealth.