Monday, July 23, 2007

An Impromptu Lesson

Over the weekend, dd16 and I had a little impromptu "Life Prep" lesson, spurred by a letter I received in the mail.

The letter was from the bank where dh and I have our personal checking account; as they have about a million times before, they're offering us a home equity account. But this time, they spelled out exactly how they believed we would benefit from borrowing against our house to pay for the necessities of life. The example they chose was so illuminating that I just had to share it with our teenage daughter.

Here's the tempting little scenario they set up:

Current Monthly Debts Before Tapping Into Home Equity:
Personal Loan $8,000 balance = $183.05/month repayment
Auto Loan $12,000 balance = $237.61/month repayment
Credit Card $5,000 balance = $112.50/month repayment
Total Current Debt Payments Per Month: $533.16

Those loan balances add up to $25,000, and the bank (out of concern for us, I'm sure) points out that if we had that kind of debt, we could take out a home equity loan for $25,000, pay off those balances and end up owing the bank only $166.16 per month. That's a savings of $367 per month or $4,404 per year. What's not to like?

So I sat down with dd16 and went over this offer with her, after dutifully pointing out that the prudent thing to do would be to not carry a balance on your credit card or extend the term of a personal or car loan in the first place. She thought that it looked like a pretty good deal, when you just crunched the numbers.

That's when I showed her the three little asterisks buried in the copy. We found the related explanation on the back of the letter in the fine print:

This 6.99% APR fixed rate would result in 179 monthly payments of $166.16 plus a final balloon payment of $21,613.82, and assumes an open and active personal (BANK NAME) checking account with automatic monthly payments from a personal (BANK NAME) checking or savings account. (For loans without a personal (BANK NAME) checking account and no automatic payment deductions, the APR would be 8.24% and would result in 179 monthly payments of $187.64 plus a final balloon payment of $22,225.93.)

I told her that a balloon payment must be paid in full on the specified date. She was pretty shocked that someone would have to come up with that kind of money, which isn't that much less than the previous 179 payments (15 years!) put together. I told her the bank is assuming the house will be worth more then and the owner would have more equity in it, so the owner could just borrow against it some more 15 years down the road.

But that assumes house prices and people's incomes will continue to go up for the next 15 years. Given the changes we're seeing from the global economy, that's a gamble.

This brief lesson caught my daughter's attention, and I think we'll go over it again this year after we do the Mortgage Project in Life Prep. But now I'm thinking, do I need to add home equity loans to that project before we do another reprint of the book? Banks and mortgage companies have come up with so many new ways to keep people in debt that I could probably add a whole 'nother book's worth of content!


Janet said...

Oh, that just makes my head spin! I have such a hard time with that stuff. That's why I LOVE my budget. I have one, I stick to it. My husband does the rest. I KNOW I should learn it, but my mind is just not set up for MATH! I'm SO happy to hear that you are teaching your daughter those things. I think finances are practical aspects often neglected. Our home school group offers a finance course to teens, which I will DEFINITELY be doing when my kids get older!

Heather_in_WI said...

Great post. Scary that people might sign up for the loan and not notice the balloon payment!

Sebastian said...

Great job. My college organized "career starter loans" in spring of junior year. The students refered to them more as "car loans." The great deal was that you didn't have to start payments on the loan until you'd graduated (and were therefore employed). What I never managed to realize was that interest was building up every single month of that deferment. I was shocked when I realized what I'd let happen and how much I could have saved by just paying $50 per month on the principal over those months.
There really are lots of great teaching moments around like this. We had a great one last fall when we took the time to read the whole page of fine print for one of the big games at McDonalds. What are the real chances of winning the million dollar instant prize? That's a big number.

mckinney said...

That's a brilliant lesson. Too bad so many adults out there haven't learnt that particular one. (I'm an appraiser, so I see this sort of thing every day.) It's frightening what people get themselves into by only looking at that "easy monthly payment."

Eleanor Deakin said...

File this one under "if it sounds too good to be true, it probably is." Alternatively, "don't trust the banks."

I can't believe those "balloon payments"; for that I could buy a balloon and fly away in it!

Dana said...

Oy...haven't gotten that. They are still trying to get me to take a loan against the house to finance my vacation. Uh, yeah. Great idea. Who needs a house when Tahiti is calling?

Barbara Frank said...

Janet, I don't think you can ever start teaching your kids about money too early.

Heather, you have to wonder how many people don't read what they sign.

Sebastian, that's awful! How do those people at your college sleep at night, misleading students who are already going broke paying for tuition and books?

Mckinney, you're right. I'm afraid we're going to suffer the after-effects of people neglecting to look beyond the "easy monthly payment" of the mortgage they got in 2005 or 2006.

Eleanor, you're right about not trusting banks, and this one is my local bank, not some far off institution!

Thanks, all, for posting!

Bunny Trails said...

Excellent post, Barbara! It is SO important to learn such lessons; the earlier, the better. Sadly, that's how so many get sucked further into the vortex of debt.