Michael Noonan has done the people a service. He has begun the process of rolling back the years of crushing austerity.
In a number of areas, Mr. Noonan and his team have taken important steps that sets the Government in a new direction.
In the area of pensions, confirmation that the Government will end the .6% levy is more than welcome. The introduction of the levy a number of years ago sent the wrong message to those who heeded Government calls to plan for retirement. Many complained that the levy was a penalty for being prudent; they had a point. Today, Mr. Noonan and his team have done the right thing by ending that punitive levy.
On DIRT, the decision to be imaginative is welcome. First time buyers always need assistance and the punitive 41% DIRT on what little income they were earning was sapping, today’s announcement ensures that prudent savers preparing to buy a home are helped instead of hindered.
Other measures announced by Mr. Noonan and his team are also positive, including changes to USC, water charges relief and reduction of the 41% tax rate to 40% means that while this is not a giveaway budget, it is not a takeaway one either.
Overall, it is the direction of this Budget that matters. After such a prolonged period of austerity that sapped the finances of families up and down the country, the beginning of the end of crisis in the State finances is finally emerging.
Mr. Noonan and his team may not be the most popular guests at the Christmas party, but beginning this year, it appears that they will again make the guest list and that is a big improvement!
Senior managers in well-known brands do not always have a fundamental grasp of key financial terms. I discovered this earlier this year while completing a graduate programme.
Business is a game and the method by which the score is kept is through finance and managers that do not understand how the score is kept are putting themselves at a serious disadvantage.
One common mistake made by managers is that finance is accounting, which is not accurate. Accounting does prepare books but accounting prepares the historical books of a company, by their nature they look back. Forward projections is where finance comes in.
Understanding and disseminating financial statements poses a challenge to some managers, especially if they graduate up the company hierarchy from a non-financial background.
Managers across company hierarchies should know key terms, including NPV, IRR, CBA, Time Value of Money and much more.
The reason for this is simple, their careers require it, especially if they hope to progress. For managers seeking funds for projects and future growth, as part of ‘lean’, capital budgeting is a must!
I have developed a programme for professionals and managers where they can learn to master a broad range of key financial terms.
I have also made a lot of interesting discoveries along the way, including some of the fears professionals and managers have of finance, many of which are irrational but powerful. For example, one manager with a PhD in a senior position was so afraid of “making an a**” of themselves, it was simply easier to not ask questions. Little wonder they never spoke up when they had legitimate questions on important trends.
Finance is not complicated…it has simply been constructed to appear so. With the right tools and a little patience, anybody can master it.
I just carried out a review of the mortgage lending market back in 2008 and ran some figures on the impact the proposed 20% deposit rules could have had on the market back then. What I was particularly interested in was the number of borrowers using mortgage credit in excess of 80%.
First, looking at the overall new homes market, some 63% of all loans granted and drawn down exceeded 80% in the Dublin area.
Nationally, the figure was a little lower at 52%, perhaps borrowers were a little more prudent or lenders more cautious?
Examining the second-hand property market in Dublin, the percentage of loans greater than 80% LTV was 56% while across the entire country, the figure drops to 50%. Second hand homes incurred a significant stamp duty liability and so, were often avoided by first time buyers. Lenders reserved 100% finance for first time buyers only.
What is interesting about the overall mortgage statistics is when I look at first time buyer market in Dublin between 2004 and 2008, almost 9 in 10 mortgages (87%) had LTV’s that exceeded 80%.
The proposals on restrictive lending put forward by the Central Bank today are interesting, especially the 20% deposit.
One area it has not identified for reform is the actual loan terms such as loans that exceed 30 years in duration. As I teach students in my MoneyWhizz financial education classes, the longer one holds a debt, the less costly it appears to be but the more cost it actually is. This is a function of the time cost of money.
I believe that no mortgage should exceed 30 years as such loans create extraordinary artificial affordability and significantly increase the cost of credit to consumers through higher interest charges.
My main concern with the proposed 20% deposit rules is they may restrict the financially prudent, especially those whose mortgage repayments may actually be lower than their monthly rents.
However, while the direction that the Central Bank is now taking is the right one, it could go further in some areas. The stability of the banks must be weighed equally against the stability of consumers.
Frank Conway is the Founder of MoneyWhizz, the financial education and personal budgeting resource.
In his speech last night to the UCD Economics Society, Governor of the Central Bank Dr. Patrick Honohan touched on a mortgage nerve; he referenced the possibility that the Central Bank is about to take a more proactive role in policing mortgage lending here.
Two areas singled out for special focus were the loan-to-value ratio and the debt-service-ratio. In other words, the amount of deposit one may be required to have when applying for a mortgage and the percentage of income the lender could use when evaluating their overall loan repayment capacity.
The Central Bank needs to tread carefully. While its overall direction is positive, it must ensure that it does not throw the baby out with the bathwater.
Loan-to-value ratios are an interesting beast. In the price ranges where the mass market congregates, it could be counter-productive to set possible deposit requirements too high. For example, if the Central Bank were to set 20% as an absolute, this could punish the financially prudent. For example, those that saved their deposits on their own and paid a significant rent while doing so may actually find it extremely difficult to accumulate 20% in an appreciating market.
Where the Central Bank should focus
In Dr. Honohan’s speech, there seemed to be a significant reference to restricting borrower activity and less focus on restricting lender activity.
Area of possible limits
There are 4 immediate areas where the Central Bank could have a significant market impact while protecting the long-term financial well-being of consumers:
1. Place a cap on lending terms – no loans on residential mortgages should be greater than 30 years. Presently, they are 35 years by the pillar banks.
2. Place a cap on interest rate limits – these should be annual and lifetime caps to protect Standard Variable Rate mortgages holders against excessive increases but sufficient to maintain a profitable margin for banks. These limits would ‘float’ above the ECB base rate.
3. Establish a Jumbo loan criteria and ‘waterfall’ against it with more restrictive lending , including loan-to-value limits of say 65%.
4. End interest-only lending – except as an emergency measure (for example in the case of mortgage arrears.
At the height of the property boom, 37% of all first time buyer mortgages were for 100% finance. Almost one-in-five were over 40-year terms and many first time buyers and property investors began their loan repayments on an interest-only basis, which created ‘artificial affordability’.
Financial planners must pass a series of rigorous exams before they are qualified to provide their services to the general public. Some are very good at what they do while others do what they are good at, or at least qualified to do.
A major difference comes down to focus and approach.
In today’s world of complex finance, financial planners must take on an approach that places the extended lifetime needs of the customer first, allocating time to understand not only the immediate needs of their clients, but looking beyond into new areas that will impact those needs.
If we take the example of financial planning today, it must include planning for new arrivals (children) and estate planning and demonstrating to clients how there are no longer clearly defined product needs set within particular age bands. Instead, great financial planning must take on a whole new approach and include less discussed areas of physical and mental well-being as well as practical money management needs.
Educating clients and consumers in general of the links between physical and financial health is important. In a recent Harvard University study, it was shown how smart students don’t always understand money, little wonder! Finance today has become complex consisting of less and less physical interaction with cash. It is becoming abstract, which may be great for convenience but terrible for reminding us that money, our money is a VERY finite resource which we need to manage carefully.
Financial planners, financial advisers, product producers and even schools have a duty to provide relevant financial education to consumers, in plain English. This is a core goal of both the OECD and UNICEF. This year, English school authorities have begun to introduce personal finance into the curriculum.
In the meantime, it is those financial planners that factor in the extended financial needs of their customers as opposed to the more limited product needs which sets them apart!
Frank Conway is founder MoneyWhizz.org, the financial literacy service for students and young adults.