Simpler Is Better In Personal Finance

President Obama recently proposed creating a new Consumer Financial Protection Agency to help protect consumers from aggressive financial transactions. I don't know whether we need another federal agency, but what I can tell you is that the basic rule for personal finance is simpler is better.

When transactions get complicated, you're probably reaching for something you can't afford or someone is pushing you into a high cost product. Either way, it's generally a bad deal.

Here are a few financial transactions that should raise a red flag:

• Teaser Rates. These are rates that are set incredibly low for an initial term, and then jump up later. Credit card companies love doing this, and some mortgages were structured as teasers. Consumers get abused because they focus on the immediate low payment, and neglect to calculate what it will cost over the long run. Teaser rates are usually just teasing you into making higher payments later.
• Adjustable Rates. Adjustable rate loans appear cheaper because the initial payment is usually less than a fixed rate loan. But the big surprise comes when the economy goes into a period of rising interest rates. Most borrowers don't understand how just a two to three percentage point change in rates can affect their payments. For instance, on a 30 year mortgage or line of credit, a move from 5 percent to 7 percent could raise your payments by 20 to 25 percent.
• No Interest for 12 Months. Places that sell furniture or other large household goods love to advertise things like "no interest" for 12 months. If you read the fine print, most of the interest is simply suspended. And if you fail to pay the balance by the end of the suspension period, all the interest accelerates. So they're hoping you fail, or forget, to pay off the loans during the float period.
• Leasing. If something is too expensive to buy, companies will propose leasing the item to you. Sounds good, but it often ends up costing you more because at the end of the lease you don't own the asset. And leases are often filled with all sorts of ancillary and "end of lease" charges. Car companies did this for years, until the economy collapsed. They're back at it again, and primarily use leasing to help people get into cars they couldn't otherwise buy with a traditional loan.
• Insurance. When you buy things like electronic products or large appliances, many retailers want to sell you insurance. The insurance is often a nice profit center for the retailer, and the devil is in the details of the insurance coverage, which you probably can't understand. But they usually rattle off some numbers about how just one small problem could cost you more than the insurance. This is a script the sales person is usuing to push the insurance. Generally, you're better off not buying it.

If you're thinking of entering into any sort of significant financial transaction, you should talk to someone who can help you figure out the numbers. If you have your own advisor, great. If not, think about a family member or friend who deals with financial transactions in their professional life, such as an accountant, banker or lawyer, and ask them for guidance. Most people who work with numbers are happy to show you how to avoid getting taken advantage of.

Bottom line. Complicated financial transactions are usually bad for consumers. In the end, there's no free lunch, just a more expensive lunch. So keep it simple, and ask for help when you need it.

As with all financial matters, consult your individual adviser prior to making any decisions.

Photo from of Flickr, courtesy of kowitz, CC 2.0

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