|
November 19, 2001
"I am
being pressed by my wife to refinance our current mortgage to consolidate some
of our debts, based on the recommendation of a major lender who has prepared a
detailed financial plan for us. The plan is attached. As you can see, we are in
something of a financial bind. Should we follow their recommendations?"
You
should follow their recommendations regarding income management, but not their
recommendations regarding debt management. The lender has no financial stake in
what you elect to do about your income management, but it has a major stake in
your debt management decision. The
lender wants to refinance your mortgage. This
has seriously prejudiced their recommendation.
You
have been spending almost $2,000 a month more than your income.
The result has been a rise in credit card and other non-mortgage debt to
$123,000, which is almost as much as the balance on your mortgage.
Debt payments every month now eat up 43% of your income, which is much
too high. Follow the planner�s
recommendation to reduce your expenses by at least 10%, which will allow you to
reestablish control of your budget.
When
it comes to debt management, however, you should ignore their recommendation.
They propose that you refinance your current 6.5% mortgage into a new one
at 9.16%. The new loan would exceed
the balance of the old loan to pay off some of your other debts.
Two of these other debts also have rates below 9.16%.
The weighted average rate on all your debts would rise from 7.58% to
9.09%.
The
planner justifies the higher rate on the grounds that your monthly payment would
decline, and your tax savings would increase.
The decline in payment, however, is due entirely to an extension of the
term to 30 years, which offsets the effect of the higher interest rate. (The
loans selected for consolidation include two that would pay off in 5 years if
the payment was maintained). If the
new loan had the same term as the loans that were paid off, the payment would go
up.
Tax
savings rise but mainly because of the higher interest rate.
A small part is due to conversion of some non-deductible debt into
deductible mortgage debt. Consolidation
into a second mortgage would also do this.
Indeed,
the logical alternative to the planner�s proposal is to leave your current
mortgage alone and pay off your high-rate non-mortgage debts with a second
mortgage. They don�t consider
this option. Further, they don�t
want you to consider it. It
is clear that the major purpose of the plan is to steer you into a new first
mortgage from them with an above-market interest rate.
Their
proposal would leave you substantially worse off than you are now.
If you continue to make the payments you are making now for 5 years,
without any other change, your balance would decline from $262, 214 to $161,
625. If you continued the same payment but refinanced as they
recommend, your balance would drop to $186, 599, or about $25,000 more.
And they describe this as �Your Current Debt Elimination Program�!
I describe it as larceny.
Most
mortgage loan officers are not trained to provide a financial planning service,
nor are they inclined to. It takes too much time. Their philosophy is that you only do
what you need to do to satisfy the client and get the deal done.
The
lender who approached you, however, has made financial planning an integral part
of its business plan, has developed systems to support the process, and trains
its loan officers in their use. The training is done well because the loan
officers are complete believers. I
know this because several of them have contacted me seeking endorsements, and
were shocked to learn that I did not share their enthusiasm.
Perhaps
because this is a costly way to do business, this firm charges above-market
interest rates. This in turn
requires some deceptive practices designed to lead clients to believe they are
receiving value when they aren�t. The client who accepts this pitch, who has received a
customized financial plan that may have some very good information in it, along
with a lot of attention from the loan officer, may put aside his questions about
the interest rate.
Financial
planning can be very helpful, but pay cash for it.
Planning offered free by those who will profit if you follow their
recommendations is suspect. The
risks may be even greater dealing with a planner who wants to put you into a
mortgage than with a planner who wants to sell you mutual funds, insurance or
annuities.
Copyright
Jack Guttentag 2002
| 
