The Darkest Corners of Personal Finance That You Have Probably Been In

The world of finance attracts the best swindlers on the planet. With so much money to be made and relative lack of knowledge, it is easy to see why.

Across just about all spectrums of personal finance, there are traps waiting to be sprung on willing patrons. Some traps are so good that people don’t even realize they have been swindled for years or sometimes ever! Some can even cause irreparable damage to your finances.

Chances are you have encountered some of these and even fell victim to it. When I was in high school making minimum wage I lost $350 to a swindler running a gas station carnival game that had “Thug Life” tattooed on his knuckles… sooo yeah… But that is a story for a different day.

In this article I use my particular set of skills to crack into the murkiest (yet totally legal) corners of finance to show you how they work and how to avoid them. They don’t call me the Liam Neeson of Finance for nothing!

…okay no one actually calls me that, but I mean I wouldn’t be opposed to it.

Free Cash Today!

We start our journey at the mac daddy of all finance scum, the payday loan industry. Drive through any low-income part of town and you will see them on nearly every corner with signs like “Free cash today” and “No credit check loans now”. The industry is so dirty that even the likes of Google and Facebook banned payday loan companies from advertising on their site joining bans on advertisements for guns, drugs, explosives, and porn. So I think it is safe to say that it is a dirty industry. But don’t take my word for it take a look for yourself.

Let’s say times are rough. You recently lost all your money in a dice game and now your car needs a new battery. Since you need the car to get to work you head down to the cash store to get a $200 loan. The way it works is you will write a check for the cash amount you want to receive plus the fees associated. For a $200 loan you will write a check for $250.76. The payday loan company will then cash the check upon the 15th day to receive payment. Let’s just go ahead and calculate the APR(annual Percentage Rate) for this loan:

equation 1.PNG

So for our example:

You are paying an annual rate of 661%!! That is also assuming that you pay on time! I hope that battery was worth it!

Just for fun let’s say that come next payday you don’t have the money in your account again and decided to take out another payday loan to pay your first one. So now you need a loan for the $250.76 plus a couple of groceries as well. So you go ahead and get one for $300. Now your actual take home cash is$249.24, but wait there’s more! Now you have to pay a fee of $76.14 on top of that. With that, your APR jumps to 796%!

This is the trap that all too many low-income families find themselves in. What starts out as a tough situation turns into a crippling financial burden that can be nearly impossible to crawl out of. The problem is that payday loans just mask over the underlying problem, spending more than you make.

Needless to say, I have a special hatred for these companies and am glad Google and Facebook have banned them. This industry profits directly off the back of the people who are struggling the most. It’s sickening.

Next, we take our journey to paradise where your vacation can turn from a relaxing time away from home to a stress inducing cocktail of embarrassment and anger in the matter of a 90-minute presentation.

The Nightmare In Paradise

I am of course talking about none other than the Timeshare/Vacation Club industry. A space that is so ripe with fraud you could almost call it Miami.  But when did all the pandemonium begin?

The idea began in the early 1960’s in the United Kingdom where four families would jointly purchase a vacation home. They then divided the year into four seasons in which each family had exclusive use for that season and each year they would alternate seasons.

In the mid 1970’s some enterprising entrepreneurs in Ft. Lauderdale, Florida (of course) decided to split the ownership of the rooms in a new high-rise condo building by 1/50th leaving two weeks per year for maintenance. The contract was for 25-years and was called a vacation license. The owners paid an up front price for the contract and a small per night fee that was frozen at the time of purchase. Part of the agreement was that even if the owners decided not to stay in the room for a certain year the per night charge still had to be paid. This eventually turned into what is now called the maintenance fee.

Fast-forward 40 years and the industry has exploded. It’s not a surprise since even in the 1970’s the average revenue per room was $3,500 per week. Today the timeshare deal has actually gotten much worse. The potential to make large amounts of money using this model attracted a significant amount of fraudsters and swindlers ready to get a sale at all costs.

The gig usually goes like this. On vacation in paradise, some very personable man or women will invite you to a short 90-minute presentation, which in return you will get a “gift”. This gift can range in value from a free breakfast to free cruises and tours for your vacation. You are not actually required to make a purchase with them, so the allure of just listening to a presentation and getting something for free seems like a no-brainer. But you must never underestimate the power of a good sales team.

Everything from the gift to the office workers to even some other “attendants” can be in on the gig.  A salesperson that could sell a fish a glass of water, a snorkel, and an ATV at the same time will give the presentation. They will go in hard with the emotional sells and use every psychological sales tactic known to man. Some shadier characters can even become aggressive and verbally abusive if you are not taking the bait.

Once you are sufficiently buttered up they will give you the price. The average one-week timeshare costs $19,000 with an average yearly maintenance fee of $660 that will increase with inflation. Increasingly companies are moving to a points system where you get a certain amount of point per year that can be used on multiple locations. Some are now called Vacation Clubs, but they are the same thing.

So what is the big problem with timeshares? Well, let’s assume that you purchased a timeshare at the above costs. In this case, you are paying an up front cost for some future value. Anything that has that flavor needs to be analyzed as an investment. There are a number of ways to analyze this, but I will use what is called Net Present Value. We will pull all of the benefits and costs back to present day and see if we have a positive value or a negative value.  The equation looks like this:

Since the timeshare technically lasts forever and the costs grow over time with inflation we can use the growing perpetuity equation to calculate the present value. The equation looks like this:

Here the discount rate will be what we could earn on the money if we instead invested the money. We will be conservative and use 7% for this number and use an inflation (growth) of 3%.

We have numbers for the costs, but what would be the benefits? Let’s say the main benefit would be the savings you would get with only paying the maintenance fee vs. staying in a hotel for a week. Let’s say the hotel price is $175/night. Here is what the numbers would look like:

Looks like it might be a bad deal. Using the equation above we could solve for a per night hotel cost that would make NPV zero or in other words we would break even. When you solve for this you get a hotel room price of $202 in today’s dollars. Another way to say this is for the same price of the timeshare you could stay a week a year in a hotel that on average costs about $200 per night and you don’t have to take an up front hit of $19,000. Realize this is the average. Some are below and some are above.

Now here is the real kicker for those who buy a timeshare at full price… the resale value of timeshares is essentially zero. The problem with buying a timeshare for a lifetime is that it can be a large burden on a family that may fall on hard times. There are multiple websites in which you can buy timeshares for pennies on the dollar! It’s the classic case of one man’s trash is another man’s treasure. If you take out the $19,000 out of the equation above then it is much easier to get some value out of the transaction.

So here is my suggestion: Focus on saving money and building wealth over time. Take your vacations when it makes sense and don’t waste your time on 90-minute sales pitches. The free gifts are not worth it. Timeshares and vacation clubs are chock full of black out dates and red tape. It’s probably not going to be worth the hassle. If having a timeshare just really tickles your jollies then buy one on the secondary market for a deep discount.

And yes I just wrote, “tickles your jollies”… don’t judge me.

Next we take a look at the upper middle class.

Car is Lyfe

America has an addiction that dates back to the early 1900s and that is the automobile. Throughout the years, automobiles have drastically changed along with the prices and the way people buy them.

When the car first came out everyone simply paid cash for the cost of the car. Over time the market became saturated and carmakers needed a way to get cars into more people’s hands. That is when they began financing vehicles. Nowadays buying a car for cash is practically unheard of.  But even that market can become saturated. Carmakers needed a way to lower the monthly payment for their customers so they introduced the car lease.

Leases will be sold to people as a means of owning a car without the “hassle” of up front costs. Also, they are able to switch to a new model car every couple of years, which obviously strikes a strong positive emotion in the potential buyer. What they don’t tend to mention is that car leasing is the single most expensive way to operate a vehicle. Not surprisingly it is the most profitable way for a car dealership to sell a car. Let me be clear about something, leasing is not the same as renting. It is simply another, and more expensive, form of borrowing as we will see below. (Source of equations below here)

The easiest way to see why they cost you so much money is to break down how they calculate the lease payment. There are three main parts:

  1. Depreciation Fee
  2. Financing Fee
  3. Sales Tax

Depreciation is simply the estimated reduction in the value of the car over the life of the lease. Carmakers take great care in getting this as accurate as possible. Here is how the fee is calculated:

Where the residual is the value of the car at the end of the term.

The financing fee is really where the dealerships get their profit. This is also where we can get your implied interest rate for the lease (oh yes, there is an interest rate). The financing fee uses something called a Money Factor. I really think this is just a way to confuse the common buyer so they don’t ask interest rate questions. The financing fee is calculated as follows: 

Yes, you do add the asking price to the residual. This is the method that all dealers use to calculate the financing fee. Money Factors will vary from car to car and dealer to dealer. And here is the great thing for the dealers, they are not required by law to put the money factor or the interest rate or the monthly finance fee on your lease contract. They are only required to put what they call your “Lease Charge” or “Rent Charge” on there which is the sum of all your finance fees over the term of the lease. To find your Money Factor from the lease charge you can simply divide the lease charge by the total number of months in the lease and use the formula above to calculate the Money Factor. To convert the money factor to an APR you multiply the money factor by 2400. I won't go into the derivation of the 2400 here, but you can find a good explanation here.

As you can tell, dealerships take some serious effort in trying to hide their money factors. Now, why would they do that? Well, of course, it is because the APRs found in leases can be significantly higher than those in regular car loans. WalletHub just came out with a report that actually lists the lease APRs by car company next to the APR of a car loan. Here is the table:

You can see that your lease APR can vary widely between companies. Look at Dodge with an APR of 10%! It is important to note that your credit score, where you are buying the car, and sometimes your negotiating skills can affect what the actual APR could be. But like I said before, leasing is not renting. Leasing is simply another form of financing.

Now here is the real problem with this. Just like with the timeshares there is a huge secondary market for cars! Obviously not the same levels of discounts as timeshares, but you can let someone else take the depreciation hit on the car by buying a couple-year-old used car. If you also pay for that car in cash you can avoid the financing charges altogether.

 It’s very hard to make a rational case for leasing a vehicle. As you can see above you are simply paying the depreciation costs and interest without getting any of the benefits of building some equity in the car even if it is going down in value. The fact is that 2 year old cars are just as reliable and most of the time almost identical to the new cars. I promise you that no millionaire will tell you that he made his money by leasing cars.

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