Often it is hard to tell bad advice until after you’ve followed it, however when it comes to your finances you can’t afford to follow advice in the hopes that it will be good – you have to know before you take the advice whether it is bad. When it comes to the worst personal finance advice everyone has advice they wish they hadn’t heeded – so how do you spot the good from the bad?
Consider who is giving the advice, and what their motivations are. You don’t necessarily need to be a financial expert to give financial advice – there are plenty of people who can tell you their experiences with a home loan provider or give you the name of a hot share to buy – but you do need to make sure the person giving the advice isn’t trying to make you act in a way which benefits them.
For example, a time share property sounds good – we’d all like the chance to have a holiday house to escape to and it’s especially good if you don’t have to pay full price for the property. However, those people who are telling you a time share is a good investment, a benefit to your financial situation and a good tax deduction know little about you and your situation; these people are giving this advice for their own benefit, to sell their product.
Unfortunately considering who is giving the advice is just one way of spotting poor financial advice because unfortunately many financial institutions and financial products which encourage our financial decisions can be a bad idea too. So learn more now about how to spot the worst personal finance advice for you.
Home Loan Advice
When it comes to your home loan everyone has advice to offer, and they are all quick to remind you of the gravity of this investment. However, before you consider everyone’s advice, with a pinch of salt – because you’ll run out of salt – watch out for the worst home loan advice:
The big banks are the most secure option
Yes, many big banks are secure places to choose a mortgage from, but they are not the only option and they are not the only secure option. Banks get their funds for your home loan from the deposits of their savings customers, or they borrow money to lend to you, or a combination of both. When banks struggle or in times of economic uncertainty people withdraw their savings, banks can be left with little funding to cover their loans.
However, non-bank lenders for example source their loan funds from individual investors and can’t afford to over-extend themselves. Plus, all financial institutions are regulated by independent government bodies and are also given an independent credit rating so rather than choosing a home loan provider based on perception, do your research and shop around for the combination of the best loan and the best provider.
Just get into the property market – you’ll work out how to afford it later
Yes, property can be a very safe investment as capital growth is very easy to come by when you consider that property values typically double every seven to ten years. However, just because your lender or mortgage broker tells you that you are approved for a certain amount, it doesn’t mean you should borrow it all and buy up big.
Instead, work out whether you can afford it now because deciding to cut back on takeaway, new clothes, a new car and tropical holidays sounds like a great plan, but is it one you can maintain for the next 30 years? Is it really worth it? The costs of owning a home also go far beyond just the mortgage repayments so make sure you budget for at least 1% of the property’s value each year for repairs and maintenance, plus other costs such as renovations, decorating, power bills, water bills and rates.
There is nothing wrong with starting small, or waiting a few years until you can afford to buy because making sure you are in a secure financial position will mean you can also avoid subsequent debt many home owners face such as personal debt or credit cards which they have run up trying to maintain their lifestyle.
Pay off your high interest personal debt with your low interest home loan.
Yes, this really does sound like sound financial advice because you know how much of your credit card repayment goes to the high 19% interest rate each month – why not consolidate your debts into your home loan at a low 6% interest?
This is the worst financial advice for several reasons, firstly because when you consolidate your personal debts such as your credit card into your home loan your credit card balances are zero. It is then very tempting to start spending on those cards again and so you are just running up more debt and not learning from your mistakes.
Secondly, if you pay off your credit card debt it will take you a number of years and a lot of interest, but if you consolidate that debt into your home loan, it is going to take 30 years to repay and cost you potentially tens of thousands of dollars more in interest because you are paying the debt for so much longer. Instead, look into balance transfer credit card offers which transfer your balance to a low or 0% interest card to give you a fighting chance to repay your debts responsibly.
Credit Card Advice
Credit cards do not have to be a bad financial decision, it is simply the fact that they are so easy to misuse that gives them a bad reputation. It is this reputation, coupled with misunderstanding about how credit cards really work which leads people to take bad credit card advice such as:
Keep your credit card in your wallet for emergencies
Taking your credit card everywhere you go is just asking for it to be used, if you are honest with yourself you’ll realise that anything which is a true emergency will be able to wait the half an hour it takes you to go home and fetch the card.
Use a credit card for the rewards points
This advice is often perpetuated because people assume that they need a credit card and if they’re using it anyway, they might as well be rewarded for it, but that is covered in the next piece of bad advice.
Rewards credit cards typically have a much higher interest rate than a standard credit card so if you fail to repay your balance in full, down to zero, within the interest free period of that card – making sure the card has an interest free period – then your balances can be charged upwards of 20% interest.
You are then struggling with compounding interest because the interest on your credit card debt is calculated daily, and then compounds monthly. For example, if you have an outstanding balance of $200 on your credit card rolled over after you pay the minimum on your August statement, and you are charged 20% interest your balance in September is $240. Even if you made no new purchases on your card, your remaining balance of $240 (which includes $40 of interest) is then charged 20% interest again at the end of September, so you are being charged interest on your interest and this is why credit card debt becomes so unmanageable.
Everyone needs a credit card
Not everyone needs a credit card and justifying the use of a card because everyone else does is the worst personal finance behaviour. A credit card makes sense when:
- You have a home loan with a 100% offset account. In this instance you use your credit card for all of your spending within the card’s interest free days, leaving your wages and other income in your offset account to save you interest on your loan. When your credit card payment is due, you transfer the money you need to pay off your card in full.
- Business cash flow. Big and small business owners use their bank’s money to keep their business running as they wait for their customers to pay invoices or income to come in. Again the use of interest free days gives the card holder the freedom to spend, secure in the knowledge the balance will be paid.
A credit card is also not a viable emergency fund because of the interest rate, and instead the correct financial advice would be to develop and emergency savings fund to cover car break downs, emergency doctor visits or unexpected bills, as this averts the snowball effect of new emergencies in the future such as a large credit card bill.
For every other credit card function – such as buying online or over the phone – a debit card will suffice. A debit card looks and acts like a credit card, but accesses your own transaction account rather than accumulating a balance.
Your savings are important to your personal finances because they give you freedom. With a strong savings plan you have the freedom to plan your future and your retirement, you can fund an emergency expense or a last minute work trip and you can save up for the things you want without having to put your purchases on credit. Therefore, to protect your savings, watch out for financial advice such as:
You need easy access to your savings
When it comes to your emergency fund, yes you do need easy access, but for your holiday fund, your renovation fund or your TV fund you can distance yourself from your savings. Choose an online high interest savings account from a provider which is linked to a transaction account from a different provider. This will mean that any transfers you make from your savings account to your accessible transaction account will take at least 2 days to be processed, making it harder to succumb to impulse buys and deplete your savings.
If you have a longer term goal to save for, consider locking your savings away in a term deposit account which does not allow you any access at all, but continues to earn you a guaranteed high interest rate daily.
Wealth builds wealth
Yes, the more money you have in your savings the more your savings will grow thanks to compounding interest earnings and higher interest rates tiered on your higher balances. However, wealth is not the only way to build savings, so don’t be discouraged from saving because you think you don’t have enough to start.
For example, if you have just $500 in savings and want to save some spending money for an overseas trip planned next year, put your $500 in a high interest savings account at 6.51% interest and continue to add just $100 a month and you’ll have $2,000 spending money in just a year.
Borrow from your retirement funds
Most companies offer a loan feature on 401K retirement savings plans which allow workers to borrow against the money in the account. The loans are encouraged as good financial advice because financial services companies believe that if you can tap into the retirement fund, you’ll be more willing to participate in contributions because you don’t feel as though your contributions are locked away. Plus, when you pay interest back on your 401K loan you are essentially paying interest to yourself.
However, if you lose your job your 401K loan must be repaid in full within just a few weeks and if you can’t repay the loan amount the outstanding balance is taxed, and penalised as an early withdrawal. So on top of the loan amount you have to repay, you could be paying thousands more in penalties. Plus, you can’t put your loan amount back and you miss out on the potential of future interest, for example a loan amount of just $6,800 at 8% interest could have earned you over $75,000 if you’d just left it in your account.