By Michael Woods, CFP, CIM
Making wise investment choices is only part of good financial planning. Keeping an eye on expenses and large purchases is just as important. When making a big purchase, like an RV or Travel Trailer, it is important to remain focused on what you can afford, not just what you want, and to always think of the future as well as the present. In a moment of weakness, Walter and Winnie Bago forgot these important points.
Three years ago, Walter and Winnie were in the market for a new RV and had a monthly payment in mind that they could afford in financing a new rig. Focusing on a monthly payment, though, is the wrong approach when making a large purchase; financial institutions can get creative with amortization periods and teaser interest rates that can come back to haunt the consumer. Unfortunately, Walter and Winnie had to learn this the hard way.
Walter had done some calculations based on his and Winnie’s monthly budget and believed that they could afford a new $80,000 RV. He searched online for ones he liked in that price range, narrowed down his options and took off to the local dealership to take a look. He liked what he saw in the $80,000 range, but then the salesperson showed him a bigger, fancier model. This one cost $120,000, but the salesperson assured Walter that he could afford it.
Walter sat down with the dealership’s financial rep, who explained to Walter that by making a few adjustments to the financing terms, they could have him and Winnie rolling in the deluxe RV in no time. Before Walter could blink, or read the fine print, he was signing the documents on an RV loan that had an amortization period 10 years longer than he thought was possible and an interest rate for a three-year term that was lower than his mortgage rate. But Walter didn’t care – he was heading off to Arizona in the “RV of America Taj Mahal Edition!”
Three years later, Walter and Winnie have returned home from a winter down south, and Walter is going through the mail, only to find a letter from the financial institution that holds the loan on the RV. To his astonishment, the interest rate has jumped 5% and the monthly payment is now more than he and Winnie can afford. With steam blowing from his ears, Walter decides to go to his local financial institution to refinance the RV, but is shocked to learn that they do not amortize recreational vehicles for as long as his current loan. If he were to refinance through his local institution, the payments would still skyrocket as the amortization period would be shorter.
Frustrated, Walter then looks into trading in his Taj Mahal for the cheaper model he looked at first. But because his RV depreciated as soon as he drove it off the lot, and since he has paid so little on the loan due to the long amortization period, he owes significantly more on the loan than what the RV is currently worth. Walter is stuck, and he and Winnie will now need to significantly adjust their retirement budget and travel plans.
What has happened to Walter and Winnie is similar to what happened to many U.S. homeowners leading up to, and during, the 2008/2009 financial crisis. They took on loans for assets they wouldn’t have been able to afford without the low teaser interest rates and long amortization periods, and when the loans reset, they couldn’t afford them. By that time, the assets were worth less than the debt, so there was not much they could do.
While it could be tempting to upgrade to the nicer model on any purchase, remember what Walter and Winnie have learned: if something seems too good to be true, it probably is.
Michael Woods is a Portfolio Manager at Odlum Brown Limited.
The information contained herein is for general information purposes only and is not intended to provide financial, legal, accounting or tax advice and should not be relied upon in that regard. Many factors unknown to Odlum Brown Limited may affect the applicability of any matter discussed herein to your particular circumstances. You should consult directly with your financial advisor before acting on any matter discussed herein. Individual situations may vary. Member-Canadian Investor Protection Fund.