How to stress-test your money

Once upon a time, “stress-testing” was an action the government demanded of big banks; now experts say we all have to do it.

It’s the short-hand for checking you could stay on top of your money if things became more expensive – and they probably will.

The interest rate rise last week was a shot across the bows – a reminder that ultra-low rates are not the norm. The move is unlikely to be the start of a huge or rapid rise in the cost of borrowing.

But it will mean added pressure on household finances that are already walking a tightrope between getting by and falling further into debt.

UK household debt is already worse than at any time in modern history. The StepChange debt charity estimates nine million people are using credit cards to make ends meet every month.

At that kind of tipping point, even the smallest increase in the cost of debt and mortgages could see millions of households tipping over the edge. But could that include you?

1. Start with the basics

Before you start working out the “what ifs” start with the “right nows”. What are you spending every month and where could you save money?

“It’s time to review your budget,” prompts Jeanette Makings, head of financial education at Close Brothers. “Some workplaces offer a budget planner, and if available, using tools and modellers like this are really helpful.

“These enable you to identify what the gaps are, what you need to do, and also nudge you into action. Setting out a clear budget, even if just done annually, makes a real difference, and an interest rate rise should act as a good prompt.”

Lianna Brinded, head of Yahoo Finance UK, adds: “First you should include everything that definitely comes out of your account each month to get a total fixed amount, such as, your mortgage or rent, loans and credit cards, and council tax, as well as direct debits like gym memberships.

“Then look at average spending on essential items that are a bit more fluid in terms of totals, such as commuting costs, food, and clothing.

“Finally, look at your incoming funds – only include guaranteed income, such as your salary that goes into your account each month. If you don’t have a set wage, put in an average of the last six months-worth of earnings.”

Now tot it all up. If you’re left with a little extra – your disposable income – be sure it’s enough to live on. If there’s nothing left, and you’re often plugging gaps with credit cards or overdrafts, see where you can cut costs and sacrifice spending to bring you back into equilibrium.

2. Assume nothing

That rate rise many only have been a tiny increase for now, but it’s still tempting to presume that if the interest rate on your debts will go up, so too will the interest on your savings to plug the gap. They won’t.

“The assumption is that banks and other financial institutions will pass on any rise in interest rates to clients who have savings in cash,” says Jamie Smith-Thompson, managing director at Portafina.

“This could be a standard savings account, a cash ISA, or even the cash element of a pension.

“The reality is usually very different. Any increases that are passed on for people with cash savings generally range from negligible to zero. In fact, banks and financial institutions often see cash savings as a bit of a profit centre. Cash has even been referred to as ‘muppet money’.”

3. Now apply the “what ifs”

While the 0.25 per cent interest rate rise has minimal impact on personal finances right now, the consensus is that the central bank will eventually have a “new normal” base rate of around 2 per cent to 3 per cent.

“Considering rates are only at 0.75 per cent at the moment, that ‘new normal’ will undoubtedly cause a spike in some outgoings,” adds Brinded. “For example, if you look at some main mortgage deals from Nationwide, a rate rise to reach 2.25% will lead to an extra £158 per month on a £200,000 mortgage.”

So if you’re struggling right now to be able to comfortably set aside another between another £150-£300 for just your mortgage alone, you should really start thinking about cleaning up your spending and creating a buffer zone for yourself, should rates spike.

Most homeowners have already been moved to action and taken advantage of some decent fixed rate deals. In fact, 90 per cent of mortgages taken out in the first quarter of the year were for this kind of deal that guarantees a certain interest rate for a period of time – often two, three, five or ten years.

4. Nobody relax

“There will be people with mortgage deals that are due to expire in the next year, and they could find the lending environment is very different from the one when they took out the deal,” warns Sam Mitchell, CEO of online estate agents Housesimple.com.

“They might also find they can’t remortgage and are trapped on their lender’s standard variable rate, which means they are vulnerable to rate rises.

“While there will be concerns amongst borrowers, it’s highly unlikely the base rate will shoot up – it’s more likely rates will creep up over an extended period.

“The message is to never over-stretch yourself financially. You always want to have some financial slack you can use if needs be.”

“The good news is that it’s highly unlikely that the ‘new normal’ base rate will happen for some time,” adds Brinded. “With Brexit hovering over the horizon, the uncertainty means the central bank is likely to try and minimise any nasty shocks to the system, if it can help it, like bumping up rates. In fact, it could mean that rates are cut again.”

But that’s a gamble and its worth using this strange period of calm awareness to spring clean and shore up to ensure future economic storms can’t blow you off course.