When you visit a foreign country, knowing the language and the lie of the land can help you avoid costly errors.
A trip to the financial world is no different.
Upon entering the financial world, the golden rule is ‘what the big print giveth, the small print taketh away’. Never forget this. Whenever I read a Product Disclosure Statement, I always start at the back…where the traps are buried.
Another rule is to walk away if you don’t understand what you’re entering.
Words and phrases such as simple, easy, no hassles, instant, worry free retirement, capital growth assured, guarantee, high income/low risk, capital stable, etc should ring alarm bells to any visitor to the financial world.
These are all warm and fuzzy marketing terms designed to press your emotional buttons.
When you see these words, be warned: these products are potential wealth hazards.
Knowing the language is one thing.
Knowing what to avoid is another.
Some recent media reports have reminded me of a couple of these ‘don’t go there’ products.
Last week, Four Corners aired a program titled Game of Loans. It was an exposé on the payday lending industry. Visit a payday lending site and it is peppered with the words instant, fast, easy, quick, no credit check required. What better way for a novice visitor to the financial world to get their hands on some cash?
The Four Corners program highlighted the misery suffered by those who had the misfortune to need ‘fast and easy’ access to cash.
In 2011, I wrote a book to our three daughters titled A Parent’s Gift of Knowledge (this book is also available to subscribers of Gowdie Family Wealth).
Chapter Three is titled ‘Control Debt to Avoid the Tail Wagging the Dog’.
The following is an extract from the book warning our daughters about the perils of payday lending:
‘Personal loans are dangerous but nowhere near as bad as payday advances. A payday advance is for those times when you have run out of money before your next pay is due; when you literally have no other form of cash. These lenders will give you an advance (loan) until you receive your next pay.
‘Details on payday lenders’ websites reveal that borrowers are charged a fee of $20 for every $100 they are advanced (borrowed). This equates to a whopping 20% interest rate for a period of only one or two weeks.
‘When you pay them back the $120 you borrowed, you now find yourself with $120 less in your next pay. So unless you can manage the next fortnight without the $120, you will be back in a week’s time to borrow the $120 back from them. Now you have to pay back $140 ($120 + $20 fee).
‘A vicious circle has been created. You can see how easily people can get caught in the debt trap.
‘When you have to resort to this sort of borrowing you have hit rock bottom financially.
‘Heed the wakeup call and get your financial house in order.’
The poor souls on the Four Corners program are snared in such a debt trap.
The following extract from the disclosure section on a payday lending site gives insight into the real cost of this ‘fast and easy’ money (emphasis mine):
‘Comparison Rate for a $250 loan over 2 weeks = 428.85% [Annual Percentage Rate]
‘WARNING: This comparison rate is true only for the examples given and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate. Credit fees and charges apply.’
Yes you read that right — 428.85% p.a. is the minimum rate, and additional charges may apply.
In Hamlet, Polonius’s counseled his son, ‘Neither a borrower nor a lender be…’
If Shakespeare had known about the returns on offer to payday lending businesses, he may well have rewritten that line to read, ‘Don’t be a borrower, but if you can get in on this payday lending scam, go for it son,’or words to that effect.
Several years ago, I had the opportunity to invest in a payday lending provider. The numbers were very impressive: exceptionally high return with low to medium risk. My head said ‘yes’, but my heart said ‘no’. My conscience could not reconcile such substantial profits at the expense of the financially illiterate.
If you, your loved ones or friends are tempted to wander down the ‘dark alley’ of payday lending, you will be mugged…time and time again. Do not go there.
The other slightly less ‘dark alley’ is the reverse mortgage product.
Reverse mortgages enable cash poor retirees to ‘sell their house back to the bank’. The homeowner is advanced a certain amount of money depending upon their age and the value of their home. There are no loan repayments. The interest is compounded and the outstanding loan amount is repaid when the home is sold.
The Australian published an article last week titled ‘Pensioner up for $720k to exit $300k reverse mortgage loan’.
In 2007, a Perth pensioner went to the Westpac bank to borrow $100,000 to renovate her home and buy a car.
According to the article (emphasis mine): ‘One of the bank’s financial advisers signed her up for a $300,000 reverse mortgage provided by Bluestone Equity at a fixed interest rate of 8.59 per cent.’
The pensioner received her $100,000 upfront and the balance paid in monthly payments of $3333 for the next five years.
With compound interest (and no repayments), the $300,000 loan has ballooned to a $500,000 debt. The pensioner wants out of the reverse mortgage but has found there is a slight snag. Repayment of the loan triggers a ‘break’ fee (there’s that small print again) of $220,000. The total debt owing suddenly rises to $720,000.
That ‘quick and easy’ access to $300,000 cash has become very costly.
Consumer advocate Denise Brailey was quoted as saying:‘They [reverse mortgages] are a shocker because people often don’t fully understand what they are getting themselves into. These loans are sold on the basis that “we can make all your dreams come true”.’
How many times have you heard if it’s too good to be true, it is?
People in need of cash rarely take the time to fully understand the true cost of the loan facility. The far too frequent lament is ‘if only I had known’.
Getting financial wisdom belatedly is a case of shutting the stable door after the very expensive horse has bolted.
In the March 2015 edition of Gowdie Family Wealth, I touched on the risks associated with reverse mortgages:
‘The combination of government initiatives to tighten the means test and the impending major market downturn is likely to herald in the greatest wealth transfer process in history.
‘Lifetime annuities and reverse mortgages will be the products of choice for nervous retirees.
‘After a severe market downturn, handing (some or all) your capital to an institution to have them in turn pay it back to you in monthly installments will seem like peace of mind to a good number of people.
‘The reality is an annuity income and age pension won’t be enough to fund a 30+ year retirement lifestyle (with costs rising faster than inflation). Therefore the family home will be sold off ‘brick by brick’ to a reverse mortgage institution.
‘What’s left when you die? The annuity institution has your investment capital and the reverse mortgage institutions takes the lion share of your home. The kids receive enough to bury you, host a wake and if their lucky go on a weekend holiday.’
With longer life expectancies, government cracking down on access to age pensions, insufficient retirement capital and an environment of low returns, it’s almost guaranteed retirees will be tempted to do a deal with the devil and sell their houses back to financial institutions.
If you or your loved ones are forced to go down the dimly lit reverse mortgage path, read the fine print more than once to ensure you fully understand what price is to be paid.
I can assure you, the reverse mortgage providers are well aware of the lesson in Shakespeare’s Merchant of Venice — the product small print does allow them to extract their ‘pound of flesh’ AND also the ‘blood’.
Here’s a forecast for you: in spite of everything I’ve said, in the next few years these ‘access to easy cash’ products will become much more popular.
When the next GFC hits (and in my opinion, it’ll hit with a force far greater than the one in 2008/09), more people in desperate need of cash will be forced to access these types of predatory products.
To avoid you or your nearest and dearest being one of them, take the precautions now to adopt a more conservative approach to your finances — pay down debt, take profits and put the proceeds into the bank, re-weight a higher percentage of your portfolio to cash and term deposits and learn to live within your means.
Acting in advance can avoid a lot of heartache later.
‘Better three hours too soon than a minute too late.’ — William Shakespeare
Editor, Gowdie Family Wealth