Sunday, October 17, 2010

My Neighbor's Upside-Down Boat

It hasn't seen water in two years and has been in shrink-wrap ever since last fall.  My neighbor's boat looks like the one above....

As I noted in another posting, Vehicle Madness, Knowing When to Unload you have to know when to call it quits with a boat, car, RV or other "toy" and move on.  When machinery reaches a certain age, it no longer is worth fixing - and almost everything is broken.  At that stage, it is time to "let go" and just scrap out the toy in question or sell it to some other fool.  A better idea is to sell it before it reaches that stage, and get some good resale value from it.

But what about new boats, cars, and RVs?  As I also have previously discussed, it is all too easy to get "upside down" on these things and end up owing far more on them than they are worth - and as a result, not be able to sell the item.  Backyards across America are filled with the unused and unwanted possessions of people who just "had to have" a new Boat or RV, and are now stuck making payments on a white elephant.

My neighbor's upside-down boat is typical of the genre.  They went to the boat show (a really bad idea) and saw the boat on display.  They made the mistake of expressing interest in it, and before long, the salesman was talking them up, showing them how they could "afford" the boat with a low, low down payment and low monthly payments - financed over 10, 15, or even 20 years.  Since it had a bathroom and kitchen and sleeping area, they could write-off the interest as a tax deduction on a vacation home!  They'd be fools NOT to buy it!

But of course, you can't deduct your way to wealth.  All the deduction does is knock off 1/3 or so of the interest off your taxes (if you are paying about 33.3% marginal rate).  It doesn't make the boat free by a long shot.

The first year, they put the boat in the water a few times.  It was hard work, coming home from the job, hooking up the boat, towing it 2 miles to the lake, launching it, then boating, and then taking it out again.  Most evenings, they were just "too tired" to do it, and flopped down in front of the TeeVee and watched "Lost" and ate a frozen pizza.  For their vacation that summer, they spent a week on the boat, which was fun, but since they had used their other vacation time (some days you just don't feel like going to work, so why not use a vacation day?) they had little time to actually go out on the boat.

They shrink-wrapped the boat and put it in their yard for the winter.  At least they didn't have to pay for storage!  The next summer, they never seemed to "get around" to using the boat.  The shrink-wrap looked so nice, it was a shame to cut it off "just to go out in the boat".  And since their daughter got married that summer, their summer vacation was spoken for.  Pretty soon, September rolled around, and well, at least they didn't have to winterize the boat this year!

And so it went.  The longer they went without using the boat, the less and less likely it was they would ever use it.  One day, after making a monthly payment on the boat, Jim, my neighbor, decided to look into selling it.  After all, if they weren't using it, why make payments?  He paid $100,000 for the boat at the boat show, and because the loan had very little down payment, they still owed $90,000 on it.  He called the dealer, who offered him $50,000 in trade-in on the boat - if he bought a newer boat of greater value.

Discouraged, he went online and checked out NADAguides boat section.   Then he looked at Boat Trader, and other online classifieds - and even eBay.  Boats very similar to his had asking prices of $70,000 or less - which was far less than what he owed on the loan.  His boat was "upside-down" in a big way - or as some folks call it "under water".

Worse yet, Jim had no money in the bank - certainly not $20,000!  Heck, they were still struggling to pay off the credit card bills from their daughter's wedding!  If he had any hope of selling the boat, he'd have to bring $20,000 cash to the table, just to get rid of it.  He grit his teeth and wrote out the check for his monthly payment.

The boat was now an albatross around his neck - and a source of marital contention.  The monthly payment didn't seem like such a big deal at the time, but now Jim and his wife wanted to do other things, and they were tied down with a boat payment.  Worse yet, Jim was looking forward to retiring sooner than the boat would be paid off.

They thought about using the boat, but since money was tight, the cost of winterizing and re-shrink-wrapping the boat seemed kind of high.  To just use the boat once would cost them several hundred dollars in winterization bills.  Jim realized that a boat is a thing you have to use a lot, in order to justify the overhead and expense.

He thought about not making payments on the loan and talked to a lawyer friend of his.  The finance company would repossess the boat, his friend told him, but then sell the boat at auction for what it could get for it.  They would also report his default on his loan, which would affect his credit score, which would make it harder to borrow money in the future, and possibly increase the rates on his existing credit cards.  Worse yes, the finance company could "come after" Jim for the difference between the loan amount and the amount from the auction sale.  This did not cheer Jim up much.

Once home, Jim decided to try to figure out how many more payments he'd have to make before he was no longer "upside-down" on the loan.  He cranked the numbers on a mortgage amortization program he found on the Internet, which produced a chart illustrating loan balance and interest paid for each successive month down the road.  Since the boat loan had a low down payment, and was in fact a risky loan, the interest rate was quite high.  For each monthly payment, the bulk went to interest, with only a tiny fraction paying down the principle amount.  Jim shuddered in horror to realize that it would be five more years before his boat loan was paid down to the $70,000 level.

This graph illustrates the depreciation on the boat (blue) versus the amount owed (red) and the cumulative interest paid (yellow), at 10%, which is typical on a high-risk loan.  It is amortized over ten years to make the monthly payment "affordable".  But as we see here, it means the owner is "upside down" for at least seven years into owning the boat.  Moreover, he pays over half the price of the boat, over time in interest payments.  This is a horribly bad bargain and a good way to get into serious financial trouble, fast.  Why do banks loan money like this?  It is, to say the least, reckless.

What was worse, which Jim did not realize, was that by the time he had paid down the loan that far, the boat would be worth $40,000 to $50,000 at best.  In other words, he would still be upside down, by about the same amount.  His loan payments were chasing the depreciation on the boat - and the depreciation was winning!  It would be six to seven years before the balance on the loan equaled the value of the boat, by which time, the boat would be worth 1/3 its original value, if not much less.

Note in the chart above, I am showing the boat value and loan value starting out at $100,000.  Many boat dealers in the past would do 100% financing.  But it also reflects the situation even with a 10% down payment, as the minute Jim drives the boat off the dealer lot, it is worth 10% less than he paid for it.  So if he paid $110,000 for the boat, it is worth exactly the balance on the loan on the day of purchase, and then depreciates rapidly after that.   Actually, in most cases, the boat is even upside-down on the day of purchase, particularly for low-down or nothing-down loans.  The chart above is for illustration purposes.  You could construct a more detailed chart using NADAguides numbers, but it would pan out about the same, I'm afraid.

Jim sought advice from his banker.  The banker said "No problem, Jim!  We can roll over that debt into a home equity line of credit - or we can refinance your house with a 'cash out' option!"  The banker went on to mention that both options, while having lower interest rates than his boat loan, would result in higher interest payments on his house.  "But since the boat no longer secures the debt, you could sell the boat free and clear!"

Of course, the banker didn't explain in detail that Jim would be rolling the "negative equity" from the boat into his house, along with a few thousand dollars in bank fees.  But, given his circumstances, it might have been the only way out.

Might have been.   The problem was, Jim already went to the well before - using a cash-out refi to pay off his credit card debts (now run back up again with the daughter's wedding).  There was no equity in the home to borrow against.

Jim was literally stuck with this boat - and boat payments - for years to come.

Sounds too fantastic to be true?  Well, I can show you the boat, right down the street.  And I can think of two or three people I know personally to whom this has happened. It happens - a lot - in America.  People just have to have their "candy" and they don't think about the future.  And unscrupulous lenders don't think about the financial stress of the consumer - they just jack the interest rate to compensate for the "increased risk."

Slick salesmen sell people expensive assets on "monthly payment" and never explain that they will be "upside down" on the loan for most of its term.  If they decide, before the end of the loan, to do something different with their lives, they are stuck, plain and simple.

And people like Jim, rather than look inwardly to see what they did wrong, join the "tea party" and decide it was the government's fault their boat depreciated.

What did Jim do wrong?  Just about everything.

1.  Never buy a boat or RV at a boat show.  These shows use high-pressure sales tactics and don't allow you much time to think or compare prices.  You are told that special sale prices are "good only for the show" as if suddenly the unit is more expensive the day after (that is, after all a law of nature, it has something to do with the space-time continuum).  Purchases like these are ones you should definitely think about - for days, weeks, months, or even years.  Deciding on the spur of the moment to buy a large boat or RV - without even test driving it - is madness.  And yet, many do - at shows!

2.  Buy a lightly used boat or RV and save a bundle.  Boats, RVs, Cars, and Motorcycles depreciate rapidly, usually by about half every five years.  Some depreciate more slowly, some faster.  But they all depreciate in value over time.  Jim's boat will be a good buy for someone else, if the finance company ever repossesses it and sells it.  Someone will get essentially the same boat as Jim bought new, for about half the price.

3.  Buy less boat or RV than you think you need.  Jim bought a huge boat, which was not only expensive, but harder to launch and handle.  They never drove it before buying it, and Jim just assumed it would handle like his smaller runabout did.  Boat and RV shows showcase interior features of boats and RVs, which people ooh and aaah over.  But they fail to appreciate it is a vehicle, not a house, and as a vehicle, it has to move under its own power - and be driven.  A large boat or a large motorhome can be stressful and a handful for many ordinary folk.  Smaller boats are a lot cheaper and a lot easier to deal with.

4.  Pay cash or use a large down payment to prevent from being upside-down.  I always pay cash for toys.  You can't afford to do otherwise.  It is a great way to prevent you from spending too much on a boat, and if you decide to sell later on, you don't have this nightmare "upside-down" scenario to deal with.  Can't afford to pay cash?  Then you can't afford it, period. 

5.  Don't buy if you have other debts!  As I noted in Selling a Car to Pay Off a Credit Card, it makes no sense to buy a "toy" or other optional item and/or incur additional debt, if you already have other debts you are making payments on.  Debt is a serious business and it should be used for serious things - a house, maybe a car (when you are starting out) and your education.  It should not be used for frivolous things like boats.

Backyards across America are filled with molding and mildewing RVs and Boats, often coated with algae, sitting at an angle as they sink into the lawn, at the corner of the lot, under a tree.  The owner is still making payments, hoping some day to be able to sell their mistake.  But of course, since they "paid so much" for the item in question, they rarely sell these nightmares, as they can't "get their price" for them.  And sitting for years and years is never good for equipment like engines and electronics.  And musty, sealed-up vehicles will rot the upholstery and develop funky smells in short order.

It is a common "nightmare scenario" played out all too often.  If you are stuck in it, I wish I had an answer for you, other than to at least use the boat (if you are going to pay for it, you might as well use it!).  But if you are thinking of buying a boat or RV, do a lot of research first.  These are too expensive to impulse buy at a Boat or RV show - or in a dealer showroom.

We have avoided this nightmare by paying cash for our boats.  And even then, we still lost our shirts in depreciation, particularly on the last one.   If we had borrowed money for that boat, we literally would have been unable to sell it, as we would have owed $45,000 on it, and it was worth only $35,000.  Many people list their boats for the balance due on the loan - and usually don't get it.  When I listed my boat for sale, some other owners of similar boats got upset, saying I sold it "too cheaply" - they had the same boat and owed far more on it that what I sold mine for.

So I lost a lot of money selling that boat (about $30,000) but at least I paid no interest (which could easily have been $15,000) and I didn't have to pay to sell the boat, and my options were flexible.  Many folks keep boats like this, if they are "upside down" and end up paying for maintenance and storage as well - for years.  Rather than take a modest hit all at once, they bleed to death slowly, over a decade.

You can buy a boat or RV and not spend a lot of money - on initial cost, maintenance and storage, and in terms of depreciation.  And the enjoyment of RVing and boating is enhanced by the knowledge that you are not going broke in the process.  You'd be surprised how nice an RV or Boat you can have, without breaking the bank.  And you'd be surprised how buying the "dream" boat or RV can often be less satisfying than you'd think - and sometimes a nightmare.

If you are not sure you want to get into RVing or Boating, rent one first!  RV rentals are not cheap, but they are far less expensive than making a $100,000 mistake if you buy one and it doesn't work out.  Similarly, if you only go boating occasionally, renting a boat might make more sense.