Toy buyers lose in borrowing game

By MARY HOLM

It appears to me that banks are being irresponsible when they allow their personal revolving credit mortgage customers to use long-term financing for their investment in "toys", such as a boat, a second car, a jetski or a recreational vehicle, which have relatively short life spans.

Also, these banks are doing nothing to allay the concerns of former Reserve Bank Governor Don Brash, who has frequently expressed his concern over the steady increase of household debt as a percentage of income.

Personal mortgage customers who have adequate equity in their residential properties and can demonstrate a sustainable cash flow can borrow money for up to 25 years for their toys.

And often these borrowers replace these toys within two or three years with a newer model, by increasing their mortgage debt.

In the case of commercial or business customers, banks usually require debt used to buy motor vehicles and plant and equipment to be repaid during the useful life of the asset - often between five and 10 years.

Surely the banks have a duty of care to explain to their personal mortgage customers that borrowing long term for an asset with a short life span is foolhardy.

If that portion of the debt relating to the toy is not repaid upon sale or disposal, the original cost of the asset multiplies many times over during the life of the loan.

We don't expect bakers not to sell cakes to people who are overweight. Should we expect banks not to lend to people who will use the money foolishly?

Before I go further, for those who don't know, if you have a revolving credit mortgage you can borrow up to a maximum level and use the money for any purpose. Interest is charged each month only on the amount borrowed.

I can see your point about people borrowing for "toys". And I'm running your letter partly to warn toy buyers that it is, indeed, a bad move to borrow to buy anything likely to lose value - particularly if you borrow long term to buy something you will use up quickly.

It's the kind of practice that leaves people many thousands of dollars poorer in their retirement.

And it would be great if banks spelled this out when they issued revolving credit mortgages. They are much more complex than cakes.

But if banks get too Big Brotherish about how those loans are used, sensible customers would suffer with foolhardy ones. A great advantage of revolving credit mortgages is their flexibility.

Nobody is forced to take one of these mortgages. Perhaps those who do must take responsibility for how they use the money.

As for the Reserve Bank, it can control interest rates and, through that, affect household debt levels.

It can also point out to the public the disadvantages of high debt - at both national and household levels.

But would it be any fairer to ask banks not to lend because household debt is rising than to ask bakers not to sell cakes because obesity is increasing?

I very much enjoy reading your column in the Herald each week.

But I wonder now, with the last few weeks only covering property rentals - where I don't think there will ever be agreement - whether it is time to move on, and only occasionally touch on the property debate.

Well, I started out this column with something different.

But I got so swamped with more good letters about rental property that I felt we needed one more week to air some readers' thoughts.

The rental vs shares issue is, after all, a central question for many investors.

But after this week, I promise we'll have more of a mix.

We don't like residential investment property, do we?

Having read your column fairly regularly for the last couple of years I get the impression you have set yourself up, perhaps unwittingly, as a sort of self-styled public enemy No 1 of (residential) property investments, leaving Don Brash in your wake, to play with his numbers.

Indeed, your attacks on property have been far more comprehensive, biased and all encompassing than any of the former Reserve Bank Governor's, but perhaps, who knows, almost equally powerful in their influence!

I can only surmise why this might be, save to say that your notoriety reached new heights at a monthly Auckland Property Investors Association meeting fronted by Martin Hawes. For in fact your name was mentioned not once but twice! A real celeb!

My point here is that you obviously don't share the same passion for property as others do.

But could you at least try to be a bit more objective and impartial in the views that you are presenting after all in a major national newspaper?

Of course, the unknowing who read your column may be deterred from property investment because of the extreme, negative views you impart whenever the subject is discussed.

Kiwis like property investment because they are clever enough to know that only they themselves have their own best interests at heart

We want a little objectivity.

Have a nice day.

How could we not, when we've just been told of our celebrity status with the Auckland Property Investors Association?

Enough royal "we's". But you started it!

I assume association members love me because my "biased and all encompassing" negative comments about rental property have indeed deterred "the unknowing", leaving all the best properties to members.

I think, though, that there might be other interpretations of what I've written.

Let me summarise my main messages about residential rental property over the years:

* First and foremost, if you own your home and also rent out a house, particularly one near your home, you have too much money tied up in one asset type.

Generally, in finance, the higher the risk you take the higher the expected average return.

But there's one type of risk that doesn't bring higher average returns. That's the risk you take when you don't diversify. It seems silly to take unrewarded risk.

I'm not saying house values are likely to fall over more than short periods.

But I am saying that the average person who concentrates on housing won't do as well - given the risks they take - as the one who spreads their investments around fixed interest, shares and property.

* Property is not as volatile as shares. But investors in shares or share funds usually don't borrow. On the other hand, investors in rental property usually use a mortgage, often on a high percentage of the purchase price.

This gearing increases volatility. A highly geared rental property is arguably more volatile than an ungeared investment in a single share.

In either case, you might double or triple your money, or more. You might also lose all your money. In the case of a geared investment, you might even end up owing money.

There's an easy way to get rid of single-share risk, by investing in a share fund. That reduces volatility hugely. But there's no easy way to invest in lots of residential rentals.

* Rental property can be more hassle than newcomers realise. Many landlords report this.



Where's the bias in those three points? Piles of academic research backs up the first point. Years of writing about personal finance back up the other two.

You don't think there could be just a tiny bit of bias in the way those who have a "passion for property" read what I say, do you?

I think the article last Saturday was seriously misleading.

The return on houses is understated because you haven't included rental income.

If that were included, even at a modest figure of, say, 5 per cent after expenses, or a bit less after tax, then I suspect the headline would read "Property beats shares" instead of "Shares beat property".

I didn't write the headline, and I was a bit shocked when I saw it in the paper.

As I said in the column, some types of property performed remarkably similarly to shares.

I do, though, take responsibility for including only the capital gains on houses, not rental income.

I clearly stated I was doing this. As I explained, this was because of a lack of data.

I could have just plugged in a rental income number. But which number? That very much depends who you talk to.

Many landlords with mortgages find that most or all of the rent - and sometimes more - goes in interest payments and other expenses. So their rental income is zero.

For argument's sake, though, let's plug in your 5 per cent. A $100 investment in an Auckland house in December 1989 would then be worth $289 last December. In an average New Zealand house, it would be $274.

That compares with $236 in New Zealand shares and $322 in international shares.

The headline would have to say "Property and shares about equal" - which is probably what it should have said anyway!

As I said last week, though, we're looking at too short a period to conclude anything much.

Also, see my previous answer on the hassle factor and, more important, diversification.



Head1: Recent trends may

change abruptly


Body1: I realise the stock markets in the US and Europe have had a great bull run from 1994 to 2000, when the NZ dollar was weakening against its major trading partners.

But what about now, with the world stock markets in turmoil, the NZ dollar strengthening and the value of Kiwis' overseas investments getting less and less every day?

Seems to me that the passive income earner of property investment (with low interest rates, immigration increasing and world turmoil) looks by far the best asset class to be investing in at the moment.

You might be right. But what if - instead of your predictions - world stocks resume their upward path, the Kiwi dollar weakens, interest rates rise, immigration slows and the world settles down a bit?

They're all quite possible, especially the interest rate rise.

As Reserve Bank Acting Governor Rod Carr said recently, "It appears likely that further increases in interest rates will be required over the year ahead, possibly to a greater extent than we projected in March."

Based on Reserve Bank projections, floating mortgage rates are likely to be around 9 per cent next year.

You're making two classic investment mistakes:

* Looking at recent trends and assuming they will continue.

Honest experts acknowledge that forecasts of share prices, foreign exchange movements and interest rates are notoriously unreliable.

* Trying to time markets, with the idea of moving between, say, shares and property depending on what looks good.

Research shows that people who do that tend to do worse than those who choose their long-term investments and stick with them.

This is partly because trends change, sometimes abruptly, and market timers often make their moves too late.

Also, you pay fees, commissions, brokerage and possibly capital gains tax each time you move back and forth.

Make your choice for your long-term savings based on risk tolerance and diversification, not on what's happening in the markets at the moment.

* Mary Holm is a freelance journalist and author of Investing Made Simple. Send questions for her to Money Matters, Business Herald, PO Box 32, Auckland; or e-mail: maryh@pl.net. Letters should not exceed 200 words.

We won't publish your name, but please provide it and a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice outside the column.