Millennials operate personal Ponzi schemes like Bernie Madoff
Borrowing money to pay debt is the most common form of personal Ponzi scheme. Lenders cloak debt consolidation and HELOC spending as sophisticated when it’s really a fool’s errand.
The Millennial Generation was too young to participate in the housing bubble of the early 00s. Instead, Baby Boomers and Generation Xers were the sophisticated financial geniuses who over-borrowed and overpaid for housing on a grand scale. What’s the main reason they did this? They wanted free money.
Rather than learn from the mistakes of the previous generation, Millennials embrace the same foolishness. Apparently, sacrifice and planning for tomorrow are overrated concepts.
Carpe diem — “Seize the Day” — The first Ponzi
Why do people make foolishly irresponsible financial decisions? Sometimes the mistakes are made in ignorance as people learn from their own mistakes, but sometimes this ignorance is willful and people don’t want to learn a truth that might adversely impact their pursuit of short-term gratification.
People make bad financial decisions because they want to pursue their short-term (and short-lived) pleasures at the expense of long-term goals and wants. People want instant gratification, and lenders learned to use this instinct to enslave people from a young age. Not long after people discover debt, they also discover the “sophisticated” financial management technique known as Ponzi borrowing.
Personal Ponzi Schemes
What does it mean to run a personal Ponzi scheme? A Ponzi Scheme is any investment where the returns come not from the investment but from the capital contributions of new investors. If you change the terms slightly, a Ponzi Scheme is also any debt where the payment of debt comes from borrowed money rather than current wages. In that respect, personal Ponzi schemes are easy to begin and grow. Anyone can borrow money to pay debt, right?
Millennials are often described as prioritizing leisure and entertainment, but many are going into debt to fund them.
Most financial planners caution homeowners against using home-equity loans to fund short-term expenses, including vacations. Yet that is the most popular use of the money for the more than half of U.S. homeowners between the ages of 30 and 34 who have owned a home for three years or more and have taken out a home-equity loan, according to results of a recent Discover Home Equity Loans survey.
“It mystifies me that they’re taking out additional debt,” said Jackson Mueller, deputy director of the FinTech Program for the Center for Financial Markets at the Milken Institute, a nonpartisan think tank that aims to increase global prosperity.
Allow me to clear up the mystery. Millennials perceive home equity as free money. They didn’t earn it. The money magically appeared out of thin air due to the fact they purchased a house. Since this money was bestowed upon them by the appreciation fairy, and since lenders offer them access at very low rates, just like the foolish generations that preceded them, Millennials accept this nearly-free money, and they spend it.
“But it doesn’t really surprise me that they’re using alternative financing to fund certain things.”
Many millennials are shunning credit cards, looking for less expensive ways to borrow, he said.
And they feel very sophisticated in doing so. They fail to recognize the core error — spending money they didn’t earn — but they congratulate themselves on managing their debt so wisely.
Borrowing against a home can be a less expensive way to attain funds than credit cards. The average interest rate on a home-equity loan was 4.88% for the week ending Aug. 17, according to Bankrate.com; the average rate on a home-equity line of credit was 4.75%. The average credit-card rate was 16.1%. Interest on home-equity loans also may be tax deductible, said TJ Freeborn, spokeswoman for Discover Home Equity Loans.
The survey findings show that for many borrowers, “the home not only is the place they live and create memories, but also a financial asset,” Freeborn said. The results of the survey showed that 30 to 34 year-olds were also more likely than other age groups to view their home as an investment property.
In other words, they learned nothing from the mistakes of their parents and grandparents.
But borrowing against your home comes with risks. “It’s because people took money out of their homes that they went underwater,” said Deidre Campbell, global chair of the financial services sector for Edelman, a communications marketing firm that has done research on millennials and money. When housing prices fell during the last housing crash, some who took money out of their homes ended up owing more than the homes were worth — leading to a rise in foreclosures and short sales. …
Not to worry, they may also believe that real estate only goes up.
The most popular reasons the youngest group took the loans were vacations (43.3%) and emergency cash (41.8%), followed by home remodels (41.1%), medical expenses (36.2%) and weddings (31.2%). For the other age groups, debt consolidation and home remodels were the top responses.
“Home-equity loans should never be used for something like a vacation or other short-term wants,” wrote Ryan Fuchs, a financial planner … .
Pure consumer spending that acquires no tangible assets should never be financed, much less with 30-year debt. While memories of a vacation may last a lifetime, it’s pretty foolish to pay for it over 30 years.
Home remodels that add value to the property, such as redoing a kitchen or a master bath, can be a good use of home equity, Fuchs said.
Most people don’t add much value when they renovate their homes. Some improvements add more value than they cost, but most only add about $0.50 to $0.75 for each dollar spent. Some improvements, like pools or landscaping, add no value at all.
People convince themselves they add value when they renovate, but this rationalization merely masks their emotional decision to obtain something they wanted. It’s easy to justify spending $100,000 on a renovation if the owner believes (erroneously) they add more than $100,000 in value.
The bills never come due
HELOC borrowing seduces so many people because the money feels free. Most people know they must repay the loan when they sell the property, but that’s not as emotional and tangible as consumption today. People delay feeling the consequences of their decisions as long as possible, but at some point, the accounts must balance.
When people receive their closing checks — checks much smaller than they anticipated — then the reality of their behavior is difficult to deny. The money they were counting on for retirement or to move up to their next home simply doesn’t exist.
They already spent it.