Borrowing like magpies

Being from Nova Scotia, I don’t have much experience with magpies. When I visit other provinces that are full of them, everyone laughs when I have asked… What are those pretty black and white birds?

Magpies are basically slightly more interesting crows. They are known scavengers with a high degree of intelligence but most famously they are strongly attracted to “shiny” objects and will even steal them.

A while ago, I was having a discussion with a fellow advisor about how easily distracted we can all get by interest rates and that we often fail to see the total cost of borrowing. She replied: “The rate is the shiny thing.” I took it from there.

When it comes to borrowing far too many of us are like magpies. We are easily distracted by or attracted to the “shiny thing”. Each type of lending product has a unique shiny thing and I’d like to share them with you.

Mortgages: Shiny Thing = Rate

When it comes to borrowing to buy our most valuable asset, I find most of us are distracted by the rate. It’s not really our fault. Everyone knows three is less than four. Just look around at the closest bank bill board or even in branch banners, at their websites or bus benches what do you see: Rate. In fact, rate is all you see. Have you ever seen mortgage advertisement showing the total interest cost over the first five years of a thirty-five year amortization? No, because that ad wouldn’t sell too many mortgages I bet.

For many, the rate is truly a shiny thing when it comes to financing our homes. What really matters is how much to we pay in interest over the full-term of the mortgage and the balance that’s left when we are exposed to new rates.

No one seems to be focused on this at all. I’ve had so many advisors tell me about how concerned they are about rising rates on variable products. Even though I know they held those variable products themselves in the over 6% prime days of 2008 just as willingly as the under 4% prime days of 2004.

Don’t get me wrong, rate is an important factor and not to be ignored and it is the easiest thing to sell people on. However, rate isn’t the whole story. I’ve seen many a client get much further ahead by structuring their cash flow so they can pay down a variable rate, open loan much faster. The exposure to rates is reduced every time the put a dollar toward their mortgage. Sure, the rate isn’t locked in, but if done right, the risk of the rate can be nearly eliminated by proper cash flow management and rapid debt repayment.

Some are so attracted by the promise of additional miniscule discount of less than half a percent they’ll sign up for a mortgage so locked down they can’t get out of it without selling their home.

Yes, you read right.

We’ve got mortgages here in Canada where biting at a bargain rate can trap the client—literally—for five years. When those institutions advertise these options as helping clients to repay their loans faster; they don’t mention the fact these low rate lockdowns come with puny pre-payment privileges usually limited to 10%.

How is that going to help a borrower pay their mortgage off faster again?

Car Loans/Lease: Shiny Thing = Monthly Payment

I had to live this one myself. The poor sales guy didn’t know what he was getting into when he suggested I finance the car I was test driving over 84 months so I could get a really “attractive” monthly payment.

Yes, 84 months—that’s 7 years. His exact words were: “Listen honey, you could pay this car off in three years like you’re saying but I’m sure you’ve got better things to do with your money. So, why not stretch it out and have a nice light payment?”

Yes, because the car would cost less that way, right? Oh wait, it costs more that way! As you might guess, this particular vehicular procurement professional didn’t end up selling me a thing.

Too many people shop for a car with nothing but monthly payment in mind. We’ve got such long terms on car loans now that pretty soon you’ll be able to get a Maserati for low monthly payment. It will be more of a decoration than a mode of transport by the time you pay it off, but the payment won’t hurt.

I have my clients focus on repaying car loans over three years or less—try to distract yourself from the true cost of your car then. Shorter loan terms also mean that a purchaser will be more careful and clear about the value of additional cost. When that extended warranty is only a few bucks you don’t pay attention, but when it jacks up the payment by 20% you don’t just sign here.

Credit Cards: Shiny Thing = Points

Last, but certainly not least, is the credit card. People are a little more aware of their balances and in general rates on these particular borrowing alternatives, but where the shiny thing phenomenon strikes is the points.

That points tail totally wags the dog but no one looks at the cost versus the value of those points. There are a few good deals out there, especially for business owners who make large purchases with their credit card and keep the balance paid off.

The problem with points is that almost nobody does the math. I have. On the average points card with an annual fee of $125 you’ll earn about $1 worth of stuff for every $100 you spend.

So, if you charge $100,000 a year on the card and never pay a lick of interest you are laughing and as long as you can use the points.

But if you charge about $10,000 per year, you won’t even earn your fee back. For some it is tempting to disregard what you are spending because you are “earning points” after all. For example, the dollar worth of gas earned during a non-essential hundred dollar shoe purchase is not really a reward.

Points can work, but you’ve got to do the math.

Just like the management fee of a given investment is not the end of the story, being distracted by rate, monthly payment or points can get our clients off track and keep them from focusing intently on the real cost of just about anything. Next time you are listening to a client talk about any of the three types of lending products listen for their focus on the shiny thing; I’m willing to bet it will really stand out.