Monday, July 16, 2012

LOAN GUARANTOR? You must be ready to pay in the event of default!

Lending a helping hand to a friend is indeed extolled. But the pitfalls of doing so - particularly when it involves money - are often overlooked. This is particularly relevant while lending money or standing surety to a loan taken by a friend or a relative. In the latter, the guarantor will be under an obligation to make good the loan amount if the original debtor defaults. 

Liabilities of the borrower 

For the lending institution, the purpose of asking the borrower to bring in a guarantor is to secure itself in the event of default by the borrower. Therefore, in such a case, the lending institution can move against the guarantor to recover the dues. Moreover, the guarantor cannot insist that the bank exhaust other alternatives before serving the notice. "To an extent, the liability of a guarantor depends on the agreement he has signed.
Depending on the contractual arrangement, the lender can initiate proceedings against the guarantor - independently or simultaneously with the borrower - even without exhausting all the other remedies available". This means that a bank need not wait till the process of staking a claim to the debtor's estate - if liable to be attached - is completed. 

Not just banks 

It is not just in the case of bank loans that most people seek guarantees from friends. There are also cases where employees seek guarantees from colleagues to avail of loans from employee co-operative credit societies. In such loans, the society obtains authorization to debit the contributions of the guarantor if the borrower defaults.
There have also been cases where guarantors for loans from such co-operative credit societies have found it difficult to encash their savings and quit the society upon retirement only because loans for which they have provided guarantees are outstanding. 

Limited scope for recourse 

There is precious little a guarantor can do if the lending institution has followed the process mentioned in the agreement before initiating the proceedings. "Persuading the borrower to repay the dues is the only remedy. Otherwise, the guarantor will have to bear the loan amount," You could also try to get someone else to be the surety, but accepting or rejecting the proposal would be entirely up to the lending institution. 

Exercise caution 

Since there is little scope for recourse once the debtor fails to repay the loan, one should be extremely careful while giving consent to the terms and conditions of the agreement. "First and foremost, a prospective guarantor needs to determine the repayment capacity of the borrower. Second, a guarantor should be careful when an enhancement in credit limit is being granted. If the guarantor does not give his consent, his liability will be to the extent of initial loan amount.

It is equally important to read the fine print of the agreement the lending institution wants you to sign. "The guarantors should ensure that the agreement does not bind them to an unlimited liability. They should be clear about the extent of their liability - for instance, if it will hold even in the event of a willful default".
One should also insist on clarity in the procedure that will be followed, including the notice period to be served, that the creditor has to follow while invoking the guarantee. "In the agreement, the guarantor should insert a clause absolving himself/herself of the surety if the original debtor agreement is altered later, without guarantor's consent".


Thursday, May 3, 2012

“Your house is not an asset” famous words about home buyers from Rich Dad Poor Dad author Robert Kiyosaki. His basic take is that your property is really a liability, not an asset. It is a place an individual lives vs an investment. defines investment as - “the investing of money or capital in order to gain profitable returns, as interest, income, or appreciation in value.”  Can be argued that a house will appreciate in value.  But, to fit the definition, you must have bought it specifically for that purpose. Many personal financial advisors continue to peddle this school of thought.

My take however is that this advice should be customized to each specific situation, this would primarily apply if you buy a house on mortgage and you live in Kenya where interests rate are currently at 23% p.a. Lets consider this scenario;

Suppose you take a mortgage for property which you intend to live in worth Kshs 5 million today, at 20% p.a. for 15 years, Monthly payments will be Kshs 87,815/=. At the end of 15 years you will have paid interest of Kshs 10.8 M add to the Kshs 5 M principal and the total cost will be Kshs 15.8 M. Note; You need to be less than 40 years old and earning a net of at least Kshs 130K monthly to qualify for this mortgage.

Now, being a middle level executive, you will not do much else until year 2030 (retirement) and you are stuck to your job unless you pay earlier or do something extraordinary. More woes if you have to pay service charge.

Please don’t consider this an asset, it’s a darn liability. Sure you won’t sell your house on retirement even if it will have appreciated in value by five times.
For clarity a 5 M property will be a 3 bed bungalow in Kitengela or a 2 bed apartment off Mombasa Road or a mansionaite closer to the CBD.  

However, if you are a high roller then you can afford a Kshs 25 M house in the leafier suburbs’ for which you will pay Kshs 400 K monthly for 15 years!
For most Kenyans, their road to house ownership is by purchasing a plot, building at their ‘respective rate of income’, all this using short term loans. Soon enough they become home owners.

Home ownership has some distinct advantages such as the sense of security, and if not risk averse they can then leverage on the value of their home to actually ‘invest’ in other real estate or business. Having said that, the house will become your asset when you have substantially paid for it.

People have this notion of computing their net worth based on the value of the property they live and especially when they have not fully paid for it. While net worth is a nice pretty number to figure out, it is almost useless. It is a fictional number that is usually based on over valued assets and unrealistic assumptions. It is useless because you can't spend your net worth the best you can do is borrow against it.

Saturday, April 21, 2012


I have been reviewing the Kenya Credit Bureau Information Sharing Initiative Progress Report 2008-2011 with interest here. The report has been prepared by Financial Sector Deepening Kenya and the following are the key highlights;
  • That 4 banks make 90% of all enquiries.
  • That 9 banks make 97% of all enquiries.
  • That data submitted by banks composed of 203,000 individual consumers and 9,900 businesses.
  • Customer complaints very low, highest number was 9 in November 2010.
  • Banks using the credit bureau system as a ‘debt collection mechanism’ rather than a ‘risk management mechanism’.
  • Old and outdated data being loaded into the credit bureaus with the sole purpose of piling pressure on debtors to pay up.
  • There is a substantial difference between number of non performing loans reported to Central Bank and those reported to credit bureaus.
  • Highlights the fact the law only allows sharing of negative information only and by banks only.
The report recommends that as a priority Microfinance institutions and Saccos should be included in the initiative and that positive information should also be shared.

The Business Daily has also today reported on the same with a very informative interview with a credit bureau insider here and that Kenyan banks have blacklisted 213,000 customers here and that there are proposals by the Kenya Bankers Association  to have an arbiter on the disputes arising from the credit reporting process here

Tuesday, February 21, 2012


Recently an insurance agent tried to interest me to a unit linked policy of sorts and when I pressed for more information I got a very attractive write up on projected earnings over the years (if times are good), they even had an annual premium adjustment to take care of inflation! Not being very satisfied, I dug up some information.

There are many views on the unit linked policies, some say that it is the future of the insurance industry to the extent that some insurance companies only have such policies e.g. Pan African Life, others say insurance cover should not be linked with investments.

What has made investment linked insurance products grow very rapidly is trying to kill two birds with one stone, ie. having insurance protection and at the same time not missing an opportunity to participate in investment. However, it is vital to be aware that insurance and investment are two different things. People buying such investment linked products should have a clear understanding how the product works.

The policies also come in many forms and are usually combined with life and education policies and have fancy product names in the line of Maxisave, Flexi, IncomeBuilder etc. So why the tie-up with investment-linked?  A unit linked (or investment linked) policy is one in which the benefits are determined by reference to the value of a collection of investments which are broadly identified and to whose fortunes the return is linked. Typically, this will comprise a portfolio of equities, bonds and, sometimes, real property.

This arrangement might be thought of as similar to owning units in unit trusts or shares as direct investments, but legally the position is quite different. There is a contractual relationship between the policyholder and the insurer. The policyholder’s entitlement is governed by that contract, according to such events - death, maturity or surrender whole or partial - as the terms provide for. The sum payable may, subject to the nature of the event, depend on the value of the linked investments.
Simply put, a unit linked policy consist of 2 major elements, the insurance elements and the investment elements. Think of it as a hybrid product between a Unit Trust and Conventional Insurance policy.

Note that similar to any investment vehicles out there, the investment funds (part of your premium) is subject to growth and losses, based on the performance of the underlying investment activities of the funds. The fine print will normally contain the following “Investment-linked plans, like other types of investments, are exposed to investment risk. The unit price of an investment fund is linked to the total value of the plan, which fluctuates with the movements in the unit price. You may realise a gain or loss when you sell your units, and may even get less than what you invested. Past-performance of an investment-linked fund's track record is only a guide to future performance.”

A portion of premium payment is used to purchase units in the investment linked funds managed by the insurance company. The protection coverage is provided by paying the insurance charges, fees and other related expenses via the deduction of the premium or sale of units from the investment funds.

Unlike unit trust investments, the full amount paid may not always be allocated to purchase units. Before buying the unit linked policy, it is important to find out what percentage of your premium would be used to purchase units which in Kenya you are unlikely to be informed. Usually, from the beginning years a bigger portion of the premium paid is used to pay for the insurer’s expenses such as agent’s fees (typically 1st year-50%, 2nd year 30% etc) and administration costs. Hence smaller portion would be used to purchase investment units. These expenses decrease over time, the premium allocation increases to purchase units increases until it reaches 100% in later years. For most insurance companies, the 100% premium allocation takes place after the 6th to 7th years for a 15 year policy. This tells you that should you attempt to discontinue the policy during the first years, you will get much less than the premium you paid for over the years or nothing.

Now, do you remember why you bought a unit linked policy? 

So, is unit linked insurance product a good choice? Depends with your personal objectives on investment and insurance cover. However, if you can afford, and insurance protection is a significant objective, I will strongly recommend you to consider other pure insurance cover options in view of the potential risk of compromising the protection coverage due to poor fund performance. If your primary objective is for investment, then go for a 100% investment focus channel, like Unit Trust, Sacco deposits etc. Don’t let the attractiveness of having it all (investment + life protection + low premium) blind you!

Friday, January 27, 2012


–Written by Joe Mont, writer at TheStreet

Financial advisers are looking more at “behavioral finance” — how people’s thinking affects their money management.
Successful saving and investing often comes down to having the right approach. But the right moves to make, on paper, often don’t translate into the actual steps we take. Emotions and personality traits can help or hinder investing and financial planning.
“It is incredibly important, especially if you are a financial adviser, because so much of our industry looks at the really obvious things like age and income and demographics,” says Katie Libbe, vice president of consumer insights for    Allianz Life Insurance Co. of North America, of understanding the role habits and personality play. “However, there can be a big difference between a 60-year-old that has a pension but maybe was petty frugal versus a 60-year-old that may have gotten there via day trading and things like that. For financial advisers, it is really important for them to know the differences between emotional traits, values and things that aren’t so easy to discover by just looking at a fact sheet on your client.”
An Allianz study, Reclaiming the Future, included research into how financial personalities affect retirement planning. That effort included a nationwide survey of 3,257 U.S. residents ages 44 to 75.  The report describes this group as “pragmatic and grounded,” and their portfolios show that. “They are financially independent, they are comfortable taking risks and they are confident that their income will last throughout their lives,” it says. “They tend to have large, diversified portfolios and, therefore, few financial concerns.”

Another grouping with positive traits were dubbed “savvy.” They were described as “financially sophisticated,” confident and “in the know about most financial concepts.” They typically had the highest level of investible assets among the respondents, with large, diversified portfolios and the lowest level of debt. As a result, they were also the best prepared for retirement.
Even positive traits can have a potential downside, though.  In 2004,    Merrill Lynch    commissioned a study of investing personalities and investment mistakes. Nearly one-third of those it surveyed were categorized as “measured investors.” Secure in their financial situation and confident they will have a comfortable retirement, they started investing early in life, rebalance regularly and don’t try to beat the market or over-allocate to a single investment. The study says they were “least likely to be plagued by the emotions that commonly cause investment mistakes, fear and anxiety.”
Nevertheless, “even the most methodical and even-keeled investors make mistakes,” the study said, adding that “steadfastness is a virtue — up to a point. This personality type’s dedication to their investments often makes it difficult for them to let go of losing investments.”
Libbe says it is important to realize that investing mistakes related to mindset and habits are far from unique. “Investors need to be able to understand that they are not that different from other people like them and that there are things they can be doing to get back on track,” Libbe says. The following are five personality traits that can hurt your investments and financial planning.
1. The overwhelmed
In the Allianz study, the “overwhelmed” personality made up the largest segment of its respondents (32%) and, demographically, tended to have the lowest income and education level. One-third had been affected — directly or indirectly — by job loss, and they have a limited amount of investible assets.
“This group tends to have high credit card debt and meager assets,” the study says. “As a group, they tend to be somewhat pessimistic … feel unprepared for retirement” and are “unsure of when, or if, they will be able to retire.” Allianz also describes this population as, financially speaking, “in survival mode.”
All this angst doesn’t seem to be helping people with this personality trait get on track. “[They] have not done a lot of financial planning and, unfortunately, do not yet see the value in working with financial professionals, whom they generally do not trust,” the Allianz study says.   ”The difference between [them and those characterized as resilient] could simply be to decide, ‘I’m not going to give up, I’m going to get engaged, get on a plan, be more focused and do something about this,’” Libbe says. “That could start to flip you from overwhelmed to resilient.”
“Resilient folks took a big hit during the recession,” she adds. “They had done the right things, they saved in their 401(k) and put money away, and then got hit by the turbulence in the markets, had to pick themselves up, dust themselves off and start back at it again. The difference is that the ‘resilients’ became engaged, whereas the ‘overwhelmed’ had self-fulfilling prophesies. If you think there is nothing that can be done for you, then you don’t do anything.”
2. The distracted
A similar segment — 7% of those surveyed — were “distracted” personalities, many of whom are in their late 40s or early 50s and likely to be married with young children. “Caught up in the complexity of modern life, they tend to not focus on financial planning, thinking of retirement as being far off and even hard to imagine,” is how the Allianz study describes them.
They tended to have the highest income level of those who took part in the survey, the second-largest level of investible assets and live in more expensive homes in metropolitan areas. Although many saw their net worth drop significantly as a result of the economic downturn and cut back on spending, most have not changed their financial plans or reevaluated their overall financial strategy.
Allianz found that respondents displaying this personality trait expect to retire in their early 60s but would prefer to do so in their early 50s. Most are counting on getting full Social Security benefits and they rely on 401(k) plans more than any other group.
“They are worried that their savings will not be adequate for retirement, but they don’t have a plan for growing those savings,” the study assesses. “This group plans to live in the present and externalize big decisions — for example, wanting government to solve the country’s financial problems.”
The positive trait this grouping exhibits is that they are open to working with a financial planner and either already do so or plan to. “They recognize the need to invest smarter, but have not yet made the commitment to do so,” the study says.
Whereas the ‘overwhelmed’ have given up on trying to develop a financial strategy, this group just never seems to get around to it.
“They are the lowest users of financial advisers,” Libbe says. “We think about the ‘distracteds’ as people who make a lot, but they are just putting money away wherever and however [strikes them]. They really don’t have an overarching strategy, because they are too distracted with day-to-day things to get around to getting their financial house in order.”
3. Risk-takers
The 2004 Merrill Lynch study delved into what it called “competitive investors,” those who “enjoy investing and try to beat the stock market.” Even when knowledgeable and experienced, their sporting approach to risk set them up for failure. They can have a hard time letting go of losing investments and often put too much of their portfolio into one stock or investment.
“Not surprisingly, competitive investors also tend to chase hot stocks,” the study says, adding that they “are most likely to be overconfident and greedy.”
“All that enthusiasm for investing can be a detriment if left unchecked,” it says.
In a worst-case scenario, investing becomes akin to gambling, filled with risky day trades, penny stocks and other adrenaline-pumping pursuits of maximum profits.
Libbe says that risk tolerance can often fall along gender lines.
“When we separated out the men from the women, as a generalization, the women tended to be the ones who were conservative while their husbands liked to watch TV or talk to their neighbors about what stocks they were buying and what strategies they were employing,” she says. “During volatile markets, these women were saying, ‘OK, he’s had his fun, we’re not doing that anymore.’ They went from an extreme where a spouse was being a little more aggressive in the markets in order to achieve some growth and then, as they got closer to retirement or they saw their portfolios go down, they were were just moving totally towards cash. Of course, neither extreme is the right answer.”
4. Wood-knockers
A study last February by the MetLife‘s (MET) Mature Market Institute and the Scripps Gerontology Center at Miami University looked at how various characteristics affect retirement decision-making. Among those archetypes were what it called “wood knockers,” those who “think about the unexpected but rely on hope.”
“They choose optimism and sound something like this: ‘Today we don’t have any such plans, knock on wood,’” the study says. “They allow themselves to think about possible unexpected scenarios, but they are good at turning these around, creating hope-filled scenarios that don’t require planning: ‘I’d like to think things will stay peaceful, calm and sane for a few years … that we will have no crisis health-wise, that the economy will get better so things will seem more secure for everyone.’”
It refers to this as living in a “fantasy land” that can preclude necessary planning for an unknown future.
5. The overconfident
Hubris has brought many high-flying dreams crashing to the ground. When it comes to financial planning, overconfidence can be disastrous.
MetLife’s study cautions against being a “Plan B-er,” those who “regard themselves as fully awake to future risks but hold on to a contingency plan, or the idea of one, as a protection against trouble ahead.”
“They are realistic about the possibility of an unexpected scenario, but they are prone to inflated ideas about their capacity to handle them,” it says. “When their resources are not enough, Plan B-ers expect to cope, to adapt, to ‘pull back,’ to be ‘OK.’ In these cases, ‘plans’ are not necessarily carefully calculated strategies; instead they are often vaguely characterized adaptive scenarios. ‘We’re flexible. We’ll go with the flow. We’re willing to downsize if we need to.’”
These fall-back plans could ultimately be characterized as life-changing desperation scenarios: “I’d have to liquidate my house; I would have to go back into the workforce, if they’d have me.”
Libbe says finance-related characteristics can be a blend of nature and nurture. In many cases, people mimic the approach and outlook of parents or other influential people in their lives.
These personalities are not written in stone, however. People can always change and learn from their mistakes.