WE’VE heard a great deal about stress-testing lately and how this latest bank stress-testing exercise if probably one of the most expensive cases of shutting the barn door after the horses escaped in the history of global finance.
Fundamentally, the idea of a stress-test isn’t a bad thing. Engineers and architects do it all the time, thank goodness. On a personal level, we all probably instinctively weigh up the pros and cons before we make really important life decisions – like taking up or leaving a job, getting married, having another baby.
Financial choices are especially suitable for dispassionate stress-tests and a recent mortgage repossession case before the Commercial Court certainly proves how badly things can turn out without one.
The case involves a couple who agreed that their son would remortgage their family home in order that he could buy an investment property. The son failed to keep up the repayments on the new €135,000 loan, and built up €40,000 worth of arrears. The total debt is now €170,000. He has done a flit, and the parents, who cannot repay the arrears, have been given until next January to find alternative accommodation after which the sub-prime lender will take possession of the property.
High cost sub-prime loans haven’t been called ‘financial weapons of mass destruction’ for no reason. This loan was clearly not stress-tested properly by either the lender or the parents; if they were unable to keep up payments or make up any loss from their own resources, they should never have allowed the loan to proceed.
With thousands of parents having gone guarantor during the boom years on mortgage loans for their adult children, they should be doing their own version of a stress-test right now. Do you have the resources to repay the loan if your child loses their job or their income falls? Could tenants be installed quickly if needs be? Could the property be sold if it is in negative equity and could you raise a new loan to meet any shortfall?
There are loads of examples of transactions that should be stress-tested – ideally before you sign a contract or make the commitment, starting with: Buying a property: Always ask the lender for a printout of the monthly, annual and total cost of repayments at interest rates that are at least 2%-3% higher than the offered rate and over at least three different repayment terms of 20, 25 and 30 years. The effect on both monthly cash flow and the total cost of the property will astound – and humble – you.
Hire Purchase agreements: Buying on the never-never is expensive and can be very messy if you want to terminate the contract before the final payment. There may also be a final ‘balloon’ payment. Before you buy this way, see if you can purchase the item using a cheaper credit union or personal loan.
Private Education: Sending a child to a private school is a huge commitment and one that many middle-class parents aspired to over the last 20 years after third level fees were abolished. Expect to pay, at today’s fee rates, c€6,000 a year or at least €36,000 for one child over six secondary school years. Is this expense really affordable? Do you have more than one child? Can it always be funded out of income or savings, or is the family going into debt to afford this long-term commitment, say, by using credit cards, personal loans or drawing down equity in the family home?
Investments:Tens of millions of euro in after-tax savings have been lost over the decades by unwise, badly considered investment purchases. Today, investors are locking into expensive fixed term investments that can result in a loss of capital or other penalties if you withdraw your money early. They should be stress-tested based on worse case scenarios in which you might need this money sooner.
Retirement Planning: Ireland’s deep fiscal and national crisis means that everyone should be stress-testing their retirement provision, whether they work for the private sector, public sector or are in receipt of a state pension. Major pension tax relief reform is inevitable and is going to impose a ceiling on private pension funds, tax free lump sums and limit the size of annual pensions on which tax relief can be claimed.
Civil and public service pension payments are mainly unfunded by the employer (except in some semi-state companies) and are unaffordable and unsustainable. As with the state old age pension, today’s workers need to stress-test their future pension income expectations.
Everyone needs to work out how much they think they will need to live on in retirement and then come up with a plan to make up for the inevitable employer/state/personal shortfall that all three are facing.
Stress-testing is something that financial advisors (or the officials at MABS) are very good at. Pay this person a proper fee for their time and expertise…and then rest more easily.
(Copies of Jill’s personal finance guide, The TAB Guide to Money Pensions & Tax in the Recession 2011 can be ordered at email@example.com )
Money Express by Jill Kerby in association with Aviva
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