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Four quick sanity checks to stop the credit crisis killing your finances

Will the credit crunch lead to a great depression?

We can’t wish away the credit crisis. However sensible you or I have been with our investments, borrowing and spending, we can’t wind back the clock and stop bankers throwing money at poor people who’ll never be able to pay it back, and who are often now paying a far higher price – repossession, dislocation, or even bankruptcy.

The bankers did it, everyone got cold feet, and now we all have to live with the consequences.

However rather than putting on The Smiths, pouring myself a large gin and tonic, and turning to Sylvia Plath, I thought it’d be more useful to assemble a checklist to help you avoid suffering too much fallout from this banker bungling. Who knows, you might even come out of the credit crunch richer! Personally, I’ll be happy with older and wiser – and not much poorer…

Today I look at personal finances. Tomorrow I’ll offer quick checks on investment, your income and more, so please be sure to subscribe to my feed.

1. Get out of debt

Because of the credit crunch, money is becoming more expensive.

I’ve written before about why you must get out of debt. But with the credit crunch being described as a great ‘deleveraging’ (in human speak, banks are reluctant to make new loans, and may even be calling them in), borrowing money instead of saving to buy things is getting even more expensive.

What it means for us

  • If you’re already in debt, I’m not saying your bank is going to call you up tomorrow and demand all it’s money back. Rather, the climate is turning against borrowers for the first time in years.
  • Banks are increasing loan rates where they can.
  • They are less willing to enable customers to shuffle debt using cheap balance transfers.
  • They will look much more carefully at impaired credit records, which will be a factor if you’ve been missing payments.

Action plan

Get out of debt, ASAP. Normally blogs work best when writers tell you personal stories, but I hate debt with a passion and have avoided it ever since I left college. If you’re struggling with debt, one of several good blogs on the subject is Blogging Away Debt. (But please comeback soon!)

2. Check your savings rate

Because of the credit crunch, banks need cash.

The main effect of the credit crisis so far has been felt by those who caused it – the banks. (The subprime mortgage defaults are a scandal, but they were not specifically caused by the credit crunch. Rather, they kicked it all off.)

Banks are very reluctant to lend to each other as normal, and when they do so they’re charging much more than in usual times.

They’re also massively unhappy to hold wacky financial products on their balance sheets, since the only certain thing about the values of these assets is that they’ve been plunging. (Every time you read about a big bank writing down a few billion dollars because of the credit crunch, that’s someone looking at a balance sheet, going “Uh oh”, then taking out a calculator and redoing the maths).

What it means for us

  • Banks want our savings, badly.
  • Interest rates for deposits are high – in some countries like the UK they are much higher than base rates.
  • Banks are effectively paying us to bank with them! They’re doing this because cash is king in a credit crisis.

Action plan

  • Take a look at the latest saving rates, and make sure you’re earning a competitive level of interest. Move your money if you’re not.

3. Work out if you need to spread your savings

Because of the credit crunch, banks are going bust.

In the UK, Northern Rock was nationalised (eventually) by the Government, after a run caused when savers got wind of the difficulties it was having raising money and tried to withdraw their money at once. The recent collapse of Bear Stearns in the US is similar, except the spooked investors were hedge funds and other financial institutions.

What it means for us:

  • Don’t assume any bank is rock solid. Northern Rock was one of Britain’s biggest 100 stock market listed companies. Bear Stearns was a giant and venerable Wall Street institution.
  • The unthinkable has been happening, and while I personally think the absolute worst is probably over for the banks, it’d be foolish to pretend anyone could say so for sure.

Action plan

  • You need to make sure your money is safe, via secure banking and any adequate safety net.
  • If your savings are with a small overseas bank for the sake of a half a percent more on your interest rate, make sure you know what will happen if it keels over.
  • Wherever you bank, find out what your maximum compensation limit is in the event the bank goes bust. In the UK, the first £35,000 savings in an account are safe – unless, ironically, you bank with the now Government owned Northern Rock, in which case 100% of your savings are protected.
  • Spread it about: If you have more cash than the compensation limit guaranteed by your country’s financial system in one bank account, take the difference out and put it into a new bank. Repeat until your money is appropriately diversified. (Make sure each bank is wholly unrelated to the others, not a subsidiary or a parent, otherwise you could get caught out.)
  • Consider National Savings in the UK – read my full savings guide for more on these 100% secure Government accounts.

4. Know your mortgage: the size of the loan, the rate you pay, and when your current deal ends

Because of the credit crunch, banks are becoming less generous with their mortgages.

For anyone except perfect borrowers, choice in the mortgage market is drying up in both the US and the UK. Crazy 125% mortgages are long gone – and good riddance – and so are 100% or ‘no money down’ mortgages. Will 90% mortgages be next?

Building societies have been voluntarily (and temporarily) closing their loan books to avoid being overwhelmed by desperate homeowners. Will we go back to the old days of rationed mortgages that banks balance against their deposits? It’s unlikely, but possible.

What it means for us:

  • Anyone who took out a short-term special mortgage may find themselves unable to remortgage onto another competitive offer if their deal expires during the credit crunch.
  • Even solid customers who took advantage of low interest rates a few years ago may be stuck with the lenders’ standard variable rate if they’ve not increased the equity in their home.
  • Mortgage rates are going up, for all borrowers, even as interest rates fall, because of those expensive interbank lending rates I mentioned earlier.
  • If you don’t know your mortgage rate, you’re probably paying too much.

Action plan

  • Dig out your mortgage paperwork, and find out where you stand.
  • Use Internet resources or call an estate agent to get a rough idea of what your house is worth, then compare it to your outstanding mortgage. Subtract the latter from the former and work out what percentage of your home you really own. For instance, if you’ve a £190,000 loan on a £200,000 home, you only own 5% of your home. This is equivalent to having only a 5% deposit – which will mean many mortgage deals are closed to you.
  • Consider saving more money between now and the expiration of your current deal to increase your deposit. (Take advantage of those decent savings rates!) If the credit crisis gets worse, a bigger deposit will help you avoid expensive deals. If it doesn’t, well, saving never hurt anybody.
  • Look at the rate you’re currently paying, and see if you can remortgage now to get a cheaper deal elsewhere. It’s unlikely, but possible if you’ve an old, ignored loan. Make sure you look at all costs (including expensive arrangement fees, for instance) before making your decision.

Tomorrow I’ll turn to investing, protecting your income, and other longer-term actions to take if you’re to not just survive but ideally thrive in these tougher times. Subscribe via RSS or my email newsletter to make sure you don’t miss out!

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