Facing up to the reality of living beyond your means

PERSONAL FINANCE:WE'VE ALL heard of negative equity – indeed many of us are stuck in the middle of it – but an even bigger scourge is negative income. This term may be far less familiar, but it reflects a much more common phenomenon.

At its simplest, it refers to a situation whereby your net income does not match your net expenditure or – to put it in language Charlie Haughey might have used – you’re living way beyond your means.

If you find yourself dipping into your savings on a regular basis, or relying on debt to finance your day-to-day lifestyle, you’re caught in the negative income trap. The only way out is to either pay down your debt or boost your income. But how do you do this in the current environment? And should you look to the services of a debt management company to help you?

Falling incomes, unemployment and rising taxes have all conspired to make meeting the cost of living a struggle. The only saving grace so far has been the exceptionally low interest rate environment. Massive amounts of personal debt taken out during the boom years – to fund discretionary lifestyle choices such as new cars or foreign holidays – are now coming back to bite.

According to Goodbody Stockbrokers economist Dermot O’Leary, the whole country is now in a state of negative income. For every €60,000 earned by an individual, about €100,000 is owed. In an international league table of personal debt, Ireland’s consumers had moved from 17th place, in 1995, to 4th in 2008. And the problem is getting worse, with debt expected to double from 5 per cent to 10 per cent of disposable income over the next couple of years.

In the first quarter of 2010, the Money Advice and Budgeting Service (MABS) dealt with almost 6,500 customers, up on the same period for 2009, while its helpline calls in the same period jumped by 21 per cent to over 7,800.

Not having enough money to meet your outgoings is a very stressful and precarious position to be in. While it may be perceived to be a problem for those on lower incomes, it is actually much more widespread, in part due to the proliferation of property investment during the boom.

With banks such as Permanent TSB now starting to clamp down on property investors, taking them off favourable interest-only repayment schedules, negative income is a distinct possibility for many.

Take, for example, someone receiving rental income of €1,000, on a €300,000 mortgage over 30 years on a 2 per cent tracker rate. Currently, they need to meet repayments, on an interest-only basis, of about €500 a month. This leaves a surplus of €500 which can be used to pay other bills. If the bank succeeds in converting such mortgages to standard repayments, however, the monthly cost of servicing this mortgage will more than double to over €1,100 – turning that surplus into a shortfall and putting more pressure on finances.

The only real solution to negative income is to reduce your outgoings, or boost your income. Given the difficulties in achieving the latter – and with more tax hikes likely in the next Budget – your best chance is to spend less. But, while for some this may just mean cancelling their Sky package or home phone line, for those suffering from a major debt hangover, it is not so easy.

According to MABS statistics for the first three months of this year, personal loans are by far the biggest problem for its customers. A frequent option for those with personal debt problems is to seek help through a debt management company.

Debt management companies, such as National Debt Relief and Debt Plan Ireland, offer to broker an informal arrangement with your creditors for unsecured loans, with you paying the agency a certain amount each month towards the cost of your debts.

However, while the concept may be attractive, be sure to work out the total cost involved before committing. Pricing structures are frequently difficult to understand, and the process may end up costing you significantly more than if you had put in the time and effort yourself. In addition, VAT, at 21.5 per cent, is levied on debt management service charges.

Moneyvillage.ie, for example, charges an initial fee of €495, which can be spread over three months. There is also a monthly transactional charge of up to €50 for five or more debts and, if you come to an agreement with your creditors for a full and final settlement, negotiated by Moneyvillage.ie, it will take 10 per cent of the amount your creditors agree to write off.

So, if you engage the services of the agency to deal with more than five debts, for a period of three years, you will be looking at total fees in the region of €2,295 – money better used to pay down your actual debt and reduce your interest payments.

Similar price structures are in operation at other providers. At Debt Plan Ireland, initial fees range from €500-€800, with an additional monthly charge of 10 per cent of your monthly repayment, from a minimum of €25 to a maximum of €70.

You will also need to be clear on how your loans are being paid down. Generally, when initial fees to the debt management agency are spread out over a period of time, it leads to reduced payments to your creditors. As a result, you may go even further into arrears and the amount owed may actually increase.

Another problem is the fact that such debt management companies usually only deal with unsecured debts – so they’re not going to help you work out repayments on your home. Your mortgage should always be the priority. Placing more emphasis on personal loans is problematic and your mortgage lender may not look too kindly on your prioritising other debts when it comes to restructuring your mortgage and dealing with arrears.

Historically low interest rates are currently cushioning many mortgage holders from having to bear the brunt of negative income, with those on tracker mortgage rates benefiting from lower repayment costs. However, while a rise in interest rates may not be on the ECB’s agenda this year, rate rises of as much as 1 per cent look likely in the short term.

Recommendations from the Government’s Expert Group on Mortgage Arrears recent first report will offer some respite for those struggling with repayments, preventing lenders from charging penalty interest on arrears and widening the scope of the mortgage interest supplement scheme. Its follow-up report, due in September, may offer some more assistance. It is due to deal with the issues of negative equity and those who are no longer able to afford their mortgages.

More help may also be on the way from the Law Reform Commission’s report on personal debt, due to be published at the end of the summer, which will offer recommendations on the reform of the law on personal debt. In the meantime, for those stuck in the negative income trap, cutting spending by tightening your belt even further, and negotiating with creditors yourself, is the best option.