Question:

Given the government guarantee on deposits, am I better to take my money out of a lower interest bank deposit and put it in a higher risk finance company with a higher interest rate now, if that finance company is government guaranteed?

Answer:

Mary Holm: Maybe. Obviously you need to be happy with how long your money will be tied up, how frequently the interest will be compounded and so on.

And you'll have to wait to see if the finance company is covered by the government guarantee.

To be eligible a finance company has to be "fully compliant with the requirements of their trust deeds".

Also, it may not "primarily provide financial services or lend to related parties and group members", and there are other restrictions.

I imagine it might take a while for the Government to confirm all that, and give finance companies the tick of approval.

Some of the less respectable finance companies - often the ones that tend to pay highest interest - probably won't ever get the nod.

And even in the finance companies that are approved, subordinated debt won't be covered by the guarantee. This is money that's repayable only after others have got their money back. It's riskier, and therefore pays higher interest - but without the guarantee I would give it a miss.

You may find that with only the non-subordinated debt of the more respectable finance companies included, there's not all that much difference in the interest your receive - especially after paying tax - unless you have a large sum and/or invest for a long time.

Some examples, based on current interest rates:

• If you invest $1000 for six months in a bank paying 7.5 per cent, your after-tax interest will be about $23 at 39 per cent tax or $25 at 33 per cent tax.

• The same investment in a finance company paying 9 per cent will give you $27 or $30, depending on your tax bracket. There's almost nothing in it.

• Even over two years, in a bank paying 6.8 per cent, you'll get $85 or $93, depending on your tax bracket.

• In a finance company paying 9 per cent, you'll get $113 or $124. It's still not much different.

However, with $10,000 you should multiply all the interest amounts by 10, and with $100,000 multiply by 100. Now you're talking differences worth getting.

Over longer periods, the differences can really mount up on large sums. But at this stage the Government's guarantee lasts only until October 2010. The scheme might be extended beyond that, but unless the international financial crisis is still with us then - heaven forbid! - I wouldn't count on it.

Another consideration is that even though a company's deposits are guaranteed, you could still face some hassle - possibly including delayed payments - if it got into difficulties. If I were you, I would still be fussy about which covered finance company I went with.

I must say I was rather surprised to see finance companies included in the guarantee scheme.

I suppose the government felt it had to, or they would be likely to lose all their business.

With their inclusion, the opposite might happen. Many people might transfer some money into finance companies, and they might prosper - although there's a disincentive for lower-rated finance companies to grow fast, as they will be charged a fee based on their growth.

In any case, I suspect most people won't bother to move their money, unless they have fairly large sums.

Footnote: I said above that finance company subordinated debt is not covered by the guarantee. It's the same for banks. However, some subordinated debt issued by building societies and credit unions - which is "in substance like a bank deposit" - will be covered.

 

 

Mary Holm is the author of bestselling books on KiwiSaver and personal finance. She is also a highly praised seminar presenter. Her written advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following that advice.