Change
People are asking for it. They want things to be different. In the world of finance that is certainly true.
Though change can take many forms. More regulation of lending is the new reality. Everyone knows credit is harder to come by now.
However, some change can be destructive. Particularly when people don't have a clear vision of what that change entails. What do they want the end result to be?
The one thing that can change the way financial world works today is through knowledge. Knowledge obtained through a thorough understanding of the basic concepts of finance and how it impacts everyone's short and long term financial health. Knowledge puts you at the centre of your financial world. Knowledge can prevent you from merely reacting to the world around you. Instead you can be proactive and engage with it.
That is what Money Skill BuildingTM is about. Giving people the tools to engage with the financial world around them. They gain knowledge of the tradeoffs involved in making financial choices. They also gain confidence in understanding the financial logic that permeates popular media. They feel more confident in engaging with their financial professional as the planning process becomes a two way street.
This blog will look at topical issues in finance. Money Skill BuildingTM will make them relevant and more importantly accessible to the reader. Money Skill BuildingTM will highlight key takeaways from each post. That way the reader can build on their understanding by taking a class or a seminar on future topics. I welcome your input and questions. Money Skill BuildingTM and the curriculum is all about interaction. No talking heads or sound bites. It's back to the classroom but the classroom is filled with discussion and mutual support. A far cry from the dry lecture room some of you remember.
Money Skill BuildingTM is not a web-based curriculum. Web-based problem sets merely reinforce what is taught in the classroom. Then the answers are covered in the classroom.
So come along and see what lively discussions we will have. And remember Money Skill BuildingTM is not about what you don't know. It's about wanting to learn.
Want to know more? Go to our website. or email us
Thanks
Anne Fitzsimons
t/a Money Skill Building
Money Skill BuildingTM does not represent or sell retail products or endorse any specific provider of such products. MSBTM earns no remuneration, commission, fee or other reward as a result of any particular decision, by anyone attending such event and arising out of such attendance, to use any particular retail financial product or any specific provider of such products. MSBTM strongly suggests that participants seek out the advice of a qualified financial professional in putting together their individual financial plan.
Tuesday, March 20, 2012
Wednesday, January 4, 2012
Neither a Borrower nor Lender Be... The Cost of Lending and Borrowing Today.
(The following is an excerpt of a morning presentation to the American Women's Club of Dublin on the day of an ECB interest rate announcement. For more details please go to Money Skill BuildingTM's website for upcoming workshops and presentation as well as classes in your area.)
We have all heard the terms "fixed", "variable", and "tracker" when it comes to mortgages and, more importantly, determining your mortgage payments. We all know that the difference between a fixed rate mortgage and both a variable and tracker rate is that the amount of the payment generally doesn't fluctuate with a fixed rate mortgage and is set over a number of years. With a variable or tracker mortgage the mortgage repayment amount generally fluctuates in accordance with a rate set by the bank or in the case of a tracker loan, rate set by the ECB. If that rate set by the bank increases, then the amount of the monthly repayment increases.
That is why some borrowers choose a fixed rate loan. Even though they pay a higher rate at first and their monthly payments are higher they prefer to know that their payment will be fixed. Of course, now with a low interest rate environment borrowers may conclude that choosing a higher fixed rate doesn't make sense. Some borrowers decide that to pay a higher payment just to "lock - in" a good rate isn't worth the extra money paid out every month. They feel that money could be better used elsewhere. And perhaps they are right.
On the other hand, if variable rates and tracker rates go up, those borrowers on trackers and variable rates will see their monthly payments go up and risk default if they don't have the cash to pay the higher amount.
So do we really understand the differences between each interest rate? How do they impact our wallet and our long term financial health?
First, while the type of rate impacts our monthly payments, the rate also impacts the bank, because there is a cost to the bank in making loans. This cost is more than the points you pay or the legal costs to close the loan and file the necessary documents. There is an ongoing cost of funds that pretty much dictates the costs to the bank and eventually the cost to the borrower.
The cost of funds is at the heart of the global financial crisis. However, Money Skill BuildingTM will focused on how the cost of funds not only impact the banks but also the borrower. It's the reason why anyone on a variable rate or tracker should know who Ben Bernanke is and why the ECB open market operations matter...but more on that later. (See below for further details)
For now we need to focus on where the banks get their funding and how they in turn make loans.
In the old days, before all the fancy financing that made the financial crisis happen, banks used to lend depositers' money. They would pay you, say, 5% on your deposit (laughable nowadays, but just an example) and then lend out the money you put on deposit at, say 10%. The difference between the cost of funds (5%) and the interest charge to you to borrow (10%) is called the interest margin and that amount went to the bank. Very straightforward.
Then the banks started to loan money that wasn't depositors'. They went to the capital markets (basically a huge market place where companies, banks and even countries go, with the help of investment companies, to advertise the fact that they have money to lend).
Banks now started to borrow money to lend money. So they could make more loans and increase revenues. They weren't confined to the deposit pool of funds. They could borrow more! Revenues could increase because they could make more loans. If they wanted to make a 20 year mortgage to Joe they went and borrowed the money in the capital markets using a 20 year bond. They knew they would be paying say 5% for borrowing the €300,000 but receiving 10% from Joe Bloggs for borrowing it. Brilliant stuff. More people could get mortgages.
But that wasn't enough. They could access another source of funding that was even cheaper.
For reasons I will discuss in class, generally the shorter the term bond the cheaper the cost to borrow. For example, if I wanted to borrow say €500,000 from the capital markets and lend it for 20 years I could borrow for 20 years and pay say 5% to do so. But if I only wanted to borrow for say 5 years I could pay only 2%. More interest margin for the bank. But I would have to go back and borrow another €500,000 in 5 years time and again in 10 and again in 15 years time in order to have funds to match all the banks lending.
Now if the bank wanted to decrease the cost of borrowing further they could borrow for 2 years at an even lower rate of, say, 0.5%. More loans and even cheaper costs of funds make for healthy profits.
What the banks then did was match the rate they were being charged to the rate that they were charging you the borrower. For example, loan on a mortgage could go from being say 10% for all 20 years to say 5 percent for 5 years, 7 percent for 5 years, and 8.5% for 10 years.
As long as the cost to borrow money for the banks was significantly less than what they charged the borrower, the banks could make money. And your rate was set according to the cost of borrowing for the bank. And if they needed to, banks could borrow from each other over night to cover any funding gap. And the rates charged to each other were so small, because they all knew each other each other's business models because they were all doing the same thing, right. What's a few hundred million among friends?
Oh dear....Well as we all know those few hundred million were really a trillion (or more) and the business models that gave everyone low variable rates and even lower tracker rates were built on a house of financial cards.
The crisis came when there was so little faith in financial institutions' ability to pay back even overnight loans. The ECB increased the banks costs of funding further by increasing the rate they charged banks. Tracker mortgages began to be more expensive. People found it harder to repay and defaults increased making lending to banks even more expensive. Regulators began asking why banks had too few deposits and so many loans that weren't being paid back. Then to make matter worse, depositors started to take money out. Paying off credit cards, a very expensive form of short term debt that the banks relied on to generate interest margin, were being paid down or off.
Finally the ECB started to lower interest rates charged to banks. However, these rates weren't being passed on to borrowers. Variable rate borrowers didn't see their rates go down. Only those on tracker mortgages. While variable rate borrowers had been paying a lower rate in the past the cost to borrow funds on the market still remain high today. So no savings. The tracker borrowers, however, remained tied to the original agreement to charge the borrower a rate that reflected the ECB's rate at the time. Regardless of the cost of borrowing.
So there you have it. A business model that promised to supply more people with more mortgages at a rate they could afford effectively blew up with the fall of Lehman Brothers and Northern Rock. As borrowers, we were left trying to figure out how a deal that seemed so financially sound could turn out to be such drain on our financial future.
That's why it is so important that while we spend locally we have to be able to look globally at our financial future. It seems that with bailouts and monetary policy driving the lending and borrowing conditions we now face, knowing how our cost of borrowing is determined is essential to planning for our future financial health.
If you want to learn more about the cost of borrowing or would just like to learn more about finance in today's world look at Money Skill Building's TM website for more information. MSBTM doesn't sell products. MSBTM just provide education and knowledge about economics and finance that relates to our world today. We look forward to hearing from you.
Money Skill BuildingTM does not represent or sell retail products or endorse any specific provider of such products. MSBTM earns no remuneration, commission, fee or other reward as a result of any particular decision, by anyone attending such event and arising out of such attendance, to use any particular retail financial product or any specific provider of such products. MSBTM strongly suggests that participants seek out the advice of a qualified financial professional in putting together their individual financial plan.
Look for us on twitter @moneyskillbld
Search for us on Facebook Money Skill Building
We have all heard the terms "fixed", "variable", and "tracker" when it comes to mortgages and, more importantly, determining your mortgage payments. We all know that the difference between a fixed rate mortgage and both a variable and tracker rate is that the amount of the payment generally doesn't fluctuate with a fixed rate mortgage and is set over a number of years. With a variable or tracker mortgage the mortgage repayment amount generally fluctuates in accordance with a rate set by the bank or in the case of a tracker loan, rate set by the ECB. If that rate set by the bank increases, then the amount of the monthly repayment increases.
That is why some borrowers choose a fixed rate loan. Even though they pay a higher rate at first and their monthly payments are higher they prefer to know that their payment will be fixed. Of course, now with a low interest rate environment borrowers may conclude that choosing a higher fixed rate doesn't make sense. Some borrowers decide that to pay a higher payment just to "lock - in" a good rate isn't worth the extra money paid out every month. They feel that money could be better used elsewhere. And perhaps they are right.
On the other hand, if variable rates and tracker rates go up, those borrowers on trackers and variable rates will see their monthly payments go up and risk default if they don't have the cash to pay the higher amount.
So do we really understand the differences between each interest rate? How do they impact our wallet and our long term financial health?
First, while the type of rate impacts our monthly payments, the rate also impacts the bank, because there is a cost to the bank in making loans. This cost is more than the points you pay or the legal costs to close the loan and file the necessary documents. There is an ongoing cost of funds that pretty much dictates the costs to the bank and eventually the cost to the borrower.
The cost of funds is at the heart of the global financial crisis. However, Money Skill BuildingTM will focused on how the cost of funds not only impact the banks but also the borrower. It's the reason why anyone on a variable rate or tracker should know who Ben Bernanke is and why the ECB open market operations matter...but more on that later. (See below for further details)
For now we need to focus on where the banks get their funding and how they in turn make loans.
In the old days, before all the fancy financing that made the financial crisis happen, banks used to lend depositers' money. They would pay you, say, 5% on your deposit (laughable nowadays, but just an example) and then lend out the money you put on deposit at, say 10%. The difference between the cost of funds (5%) and the interest charge to you to borrow (10%) is called the interest margin and that amount went to the bank. Very straightforward.
Then the banks started to loan money that wasn't depositors'. They went to the capital markets (basically a huge market place where companies, banks and even countries go, with the help of investment companies, to advertise the fact that they have money to lend).
Banks now started to borrow money to lend money. So they could make more loans and increase revenues. They weren't confined to the deposit pool of funds. They could borrow more! Revenues could increase because they could make more loans. If they wanted to make a 20 year mortgage to Joe they went and borrowed the money in the capital markets using a 20 year bond. They knew they would be paying say 5% for borrowing the €300,000 but receiving 10% from Joe Bloggs for borrowing it. Brilliant stuff. More people could get mortgages.
But that wasn't enough. They could access another source of funding that was even cheaper.
For reasons I will discuss in class, generally the shorter the term bond the cheaper the cost to borrow. For example, if I wanted to borrow say €500,000 from the capital markets and lend it for 20 years I could borrow for 20 years and pay say 5% to do so. But if I only wanted to borrow for say 5 years I could pay only 2%. More interest margin for the bank. But I would have to go back and borrow another €500,000 in 5 years time and again in 10 and again in 15 years time in order to have funds to match all the banks lending.
Now if the bank wanted to decrease the cost of borrowing further they could borrow for 2 years at an even lower rate of, say, 0.5%. More loans and even cheaper costs of funds make for healthy profits.
What the banks then did was match the rate they were being charged to the rate that they were charging you the borrower. For example, loan on a mortgage could go from being say 10% for all 20 years to say 5 percent for 5 years, 7 percent for 5 years, and 8.5% for 10 years.
As long as the cost to borrow money for the banks was significantly less than what they charged the borrower, the banks could make money. And your rate was set according to the cost of borrowing for the bank. And if they needed to, banks could borrow from each other over night to cover any funding gap. And the rates charged to each other were so small, because they all knew each other each other's business models because they were all doing the same thing, right. What's a few hundred million among friends?
Oh dear....Well as we all know those few hundred million were really a trillion (or more) and the business models that gave everyone low variable rates and even lower tracker rates were built on a house of financial cards.
The crisis came when there was so little faith in financial institutions' ability to pay back even overnight loans. The ECB increased the banks costs of funding further by increasing the rate they charged banks. Tracker mortgages began to be more expensive. People found it harder to repay and defaults increased making lending to banks even more expensive. Regulators began asking why banks had too few deposits and so many loans that weren't being paid back. Then to make matter worse, depositors started to take money out. Paying off credit cards, a very expensive form of short term debt that the banks relied on to generate interest margin, were being paid down or off.
Finally the ECB started to lower interest rates charged to banks. However, these rates weren't being passed on to borrowers. Variable rate borrowers didn't see their rates go down. Only those on tracker mortgages. While variable rate borrowers had been paying a lower rate in the past the cost to borrow funds on the market still remain high today. So no savings. The tracker borrowers, however, remained tied to the original agreement to charge the borrower a rate that reflected the ECB's rate at the time. Regardless of the cost of borrowing.
So there you have it. A business model that promised to supply more people with more mortgages at a rate they could afford effectively blew up with the fall of Lehman Brothers and Northern Rock. As borrowers, we were left trying to figure out how a deal that seemed so financially sound could turn out to be such drain on our financial future.
That's why it is so important that while we spend locally we have to be able to look globally at our financial future. It seems that with bailouts and monetary policy driving the lending and borrowing conditions we now face, knowing how our cost of borrowing is determined is essential to planning for our future financial health.
If you want to learn more about the cost of borrowing or would just like to learn more about finance in today's world look at Money Skill Building's TM website for more information. MSBTM doesn't sell products. MSBTM just provide education and knowledge about economics and finance that relates to our world today. We look forward to hearing from you.
Money Skill BuildingTM does not represent or sell retail products or endorse any specific provider of such products. MSBTM earns no remuneration, commission, fee or other reward as a result of any particular decision, by anyone attending such event and arising out of such attendance, to use any particular retail financial product or any specific provider of such products. MSBTM strongly suggests that participants seek out the advice of a qualified financial professional in putting together their individual financial plan.
Look for us on twitter @moneyskillbld
Search for us on Facebook Money Skill Building
Sunday, December 11, 2011
“Whatever you do Don’t Mention Money in polite company!” Naah, Money Skill Building says it’s time to change all that
Welcome.
“Whatever you do Don’t Mention Money in polite company!” It could have been your mother or father or someone else that told you that. There were a number of topics people weren't suppose to bring up in conversation. Let alone admit that you may or may not understand something! Those days are over and there was never a better time to put old attitudes about talking about money aside. That is what Money Skill Building and this Blog is all about.
Don’t Mention Money is a space where we can discuss some of the issues raised today in teaching and learning about finance and economics. I hope you find it useful and that you will post comments and ask questions so that can keep posts relevant and interesting. Questions about finance or learning about finance are most welcome. There are no celebrity economists here. No one to look cross and point out the error of your ways. Just information about issues that effect you and how you see your finances. The future gets more complicated by the day and the last thing we need is another space that takes our questions about our financial future and gives us sound bites for solutions. There is also a lot of pain created by the collapse of the financial system. For that reason, I ask that posts be respectful and serve the purpose of advancing answers to questions. We can all learn from each other and our experiences.
It is my belief that railing against a system that is now dysfunctional won’t in the long run make life better for anyone caught in its aftermath. Neither is demanding its destruction. While it may make those left hurt and devasted by its wrecklessness feel better in the short run, it won’t empower their financial decisions in the future.
Education is the only way to navigate the financial system. You will be able to understand how interest and inflation can increase or decrease the value of your savings, how to limit the influence of capital markets on the value of your most important asset – your home, and the trade offs between renting and owning on your financial future. Take the time to really understand what influences your finances and you will be able to manage them rather than have them manage you.
Money Skill Building is really about putting you at the center of your financial decision-making. There are no products involved and no advice given. Money Skill Building isn't affiliated with a bank or building society, or government body. This is not a get rich quick scheme. You will know nothing more about stock and shares than you may know now. Yes I have traded stocks and I continue to trade stocks. No I do not manage other people’s money. I would never ever encourage anyone to trade the stock market. Especially now! (Anyway it takes a minimum of 10,000 hours of learning and doing before you can be any way proficient (ie not lose a ton of money))
And please don’t say to me “I have about €2,000 that I don’t mind if I lose. I may as well put it in the stock market and see what happens” I am quite literally good for 20 minutes of lecturing on about how you have almost 100% chance of doing just that - losing it Safe to say we will avoid that topic altogether except in its most general of terms as a type of asset on your personal balance sheet.
I do have qualifications in financial services. I have received the Accredited Product Advisor designation and enrolled in the CPD program with the Institute of Bankers, Ireland. I am working towards my Qualified Financial Advisor qualification. I also have studied for the Chartered Financial Analyst designation. But those were to enhance my own knowledge and to keep my education up to date as best I could. Sometimes I do research on topics that are very boring to the vast majority of people and not really relevant to what I am doing in Money Skill Building.
I have also worked for a number of years in community development where I helped tenants acquire, own and manage 265 unit urban housing development. That project alone involved numerous sources of financing, legal documents, and management issues. I worked with community organizers, tenant groups, neighbourhood groups, lawyers, architects, and builders on a number of other projects to move them on to the next stage of development. All the while ensuring tenants had an affordable place to live when market rents were beyond their reach.
The only service and purpose of Money Skill Building is education. You decide the pace of the course and you are encouraged to ask questions and receive answers. There will be a classroom space on the web for you to apply those concepts that may seem hard to come by in the classroom environment alone. And this is not an online course. While there is nothing wrong with online learning and it serves a very good purpose for people who can’t access education any other way, Money Skill Building believes that shared learning, listening and, very importantly participating in, classroom discussion will increase one’s confidence in tackling concepts that at first may seem new and perhaps remote.
Thanks for reading this and my hope is that you will return for many great discussions to come.
If you want to know more about Money Skill Building, myself and the courses offered, please see moneyskillbuilding[dot]com.
And now about that interest rate cut and not passing it on to consumers…Cheers
Subscribe to:
Posts (Atom)