Taking a tight grip on household expenditure helped put a couple on a footing where more comprehensive advice may now be a possibility. Mark Story reports.
Many Australians allow themselves to splurge now and again, but few can afford to sustain a champagne lifestyle on a beer budget for very long without something going radically wrong. When you’re over-spending by a whopping $37,564 a year, and you have to take out more loans to finance the ones you’ve already got, you’re also living on borrowed time.
So when forty-something Perth couple Michelle and Dave Hill found themselves in this exact predicament early last year, they had only two choices: Drastically trim their cloth to meet their income, or risk losing everything.
And given that Michelle, a writer, had been trying to get Dave, a self-employed brickie, to seek money management counselling for well over five years, the biggest loser would have been their marriage. If the threat of divorce wasn’t sufficient for a wakeup call, it was loss of income following a work-related injury that finally convinced Dave to surrender to third- party scrutiny of their spending habits.
Faced with mounting difficulty in keeping up with loan repayments, and Dave’s income now reduced to disability insurance (following major spinal surgery), the Hills had reached desperation point. Not knowing who to turn to, they spontaneously responded to an ad placed in their local newspaper by financial planner, Rebecca Newton.
The predicament
In addition to an outstanding home loan of $195,000, the Hills also had a $20,000 overdraft, $44,672 owing on an assortment of “boy’s toys”, $15,100 on credit cards and $8444 owing in income tax – and no savings to draw on. Perhaps because of the severity of their financial situation, the Hills were in no position to pay for advice. So with one eye on developing a more enduring relationship, Newton agreed to waive all fees until after refinancing and until Dave had fully recovered from surgery.
The Hills agreed to pay 50 per cent of Newton’s usual Statement of Advice (SoA) fee, while all other fees were waived on an ongoing basis.
“Taking a longer-term view, I could see that wealth creation and other financial planning strategies would only be relevant for the Hills once more pressing issues were addressed,” Newton says.
The solution
While initial consultations and reviews identified the Hills as having a balanced appetite for investing, they had no investments (beyond Michelle’s 9 per cent Superannuation Guarantee contributions).
But given that the Hills risked losing both their house and marriage if over-spending continued, Newton’s immediate priorities were twofold: Urgently implement an expenditure reduction strategy; and consolidate their debt – and fortunately there was sufficient equity in their home to do so.
Given that implementing these strategies can be overwhelming, Newton included a “How to Proceed” page in the SoA, outlining in bullet points the action required.
Knowing full well that cashflow was a major problem, she offered four complimentary fortnightly meetings to help them implement procedures to monitor spending patterns.
Newton collaborated with the Hills on implementing the practical side of the theory, and during the first meeting all expenditure was entered into a spreadsheet. The numbers were then reviewed to identify how recurring spending patterns could be avoided.
“By the last session they seemed a lot more comfortable with monitoring their outgoings, especially when they saw their (spending) patterns changing,” Newton says.
Implementation
On Newton’s advice, the Hills borrowed an extra $8000 to cover Dave’s income tax, and rolled over both their overdraft and credit cards into one offset account – into which all earnings would be paid fortnightly.
“In addition to reducing the principal outstanding, an offset account allows money to be deposited or withdrawn at any time without charge,” says Newton.
“And as interest is calculated daily, the interest due will also reduce.”
While this saw their mortgage jump from $195,000 to $274,772, the additional debt was now subject to a substantially lower interest rate. It had been 25 per cent a year on some credit cards, compared to 6 per cent on the consolidated loan.
The results
The net effect was to slash loan repayments by $18,859 (or 41 per cent) to $26,000.
“While I have recommended a partial selldown of Dave’s assortment of cars, bikes and trailers, which would also cut insurances and maintenance costs, he has thus far baulked at the idea, much to the chagrin of Michelle,” Newton says.
Similarly, to ensure there was only one channel for all personal outgoings, Newton also recommended the Hills pay all their expenses with one remaining credit card (with a maximum $5000 limit) and pay down the monthly balance within the credit-free period. After line-by-line scrutiny of clothing, food, petrol and other incidentals, Newton and the Hills managed to reduce total annual expenses by $13,610 to $20,760. The single biggest saving came from halving their grocery expenses to $150 a week.
There was also an annual saving of around $5760 in income protection premiums – which were put on “hold” while Dave received disability income. And eliminating an additional $2000 in costs previously incurred by Michelle making jewellery for family and friends brought the total annual savings to $38,229.
Newton says having one channel for all payments and an obligation to clear them within the calendar month helped stop impulse purchases, while introducing both discipline and transparency into the family’s regular outgoings.
“During fortnightly meetings, the Hills could see clearly how a pattern of ad hoc spending was contributing to the negative cash position they’d found themselves in,” Newton says.
With debt consolidation and expenditurereduction strategies successfully in place, Newton’s next task was ensuring the Hills had sufficient death cover.
She wanted to make sure that should either one pass away, the surviving spouse and their teenage son would not be left with the burden of excessive loan repayments.
The next priority is getting Dave reinsured for death, trauma and disability insurance. But as he’s currently on-claim and hence unable to apply to increase existing cover or apply for new cover, Newton says all existing cover should remain in place.
Meanwhile, Newton recommended that Michelle, as the family’s sole breadwinner, increase her own cover to $275,000.
“It’s inappropriate that her insurance is implemented outside of superannuation, as it will affect their out-of-pocket cashflow which, at the moment, is in a negative position,” says Newton.
Unfinished business
While still work in progress, Newton would like to see a further reduction in the Hills’ fixed expenses. She estimates that by selling one of the three vehicles, one of two trailers and one of two motor bikes, the Hills could pay an extra $17,000 off their mortgage, while reducing insurances, running costs, registration and maintenance costs by an extra $8850 annually.
While the Hills’ goal of advancing to a wealth creation strategy remains a long way off, Newton says strategies implemented so far have successfully relieved the financial pressure, which may have ended their marriage.
“They’re no longer borrowing to finance loan repayments, and have one manageable loan repayment,” says Newton.
“Having successfully demonstrated their ability to live within their finances has boosted their confidence in the recommendations provided.”
Equally important, Newton says unearthing the root cause of their cashflow problems has given them a fresh focus on their finances, plus renewed commitment to maintaining and regularly monitoring their spending. And with a positive cashflow for the first time in years, she says Dave can continue his retraining into another occupation with the “peace of mind” that the family’s expenses are being adequately covered.
“I maintain monthly contact with Michelle and Dave to ensure they’re sticking to the plan, and monitor when we can arrange death cover for Dave to cover the debts,” says Newton.
Once the Hills have successfully paid down a bit more debt, they plan to seek Newton’s help establishing a wealth creation strategy. And while they’d like to invest in an inner-city rental property within three to five years, Newton’s concerned they’ll be too exposed to property within an already over-valued (Perth) market.
Instead, she plans to guide them into building up their savings via a more tax-effective super option.
So how hard was it for the Hills to be absolutely honest and up-front with Newton about their true financial position?
While Dave struggled with the process more than Michelle, she says they both finally realised that unless Newton had a thorough understanding of their true position, Newton wouldn’t be able to make realistic recommendations.
“It was a very worrying time, and we realised that unless there was a major rethink around cashflow, we would struggle to maintain our lifestyle,” Michelle says.
Given that Dave was in greater need of basic money management skills, Michelle says that he has probably benefited more from the experience than she has. And while he’s never taken Michelle seriously on such matters, she says he sits up and listens when Newton talks.
“The whole exercise has been money well spent; had we not done this we would have faced divorce and bankruptcy,” says Michelle.
“Had we sought advice when I wanted to many years ago, we’d already have that investment property.”
To the many friends who find themselves in the same boat financially, Michelle recommends they seek similar advice – but on two conditions: 1) Don’t delay, and 2) do it now – even if it means dragging hubby into it squealing.
