Tag Archives: line of credit

A Retired Couple’s Financial Nightmare

Good morning George:

My husband and I are both retired. We own our house with no mortgage. But we have a line of credit of 27,000 on it (at prime plus 1 and it keeps going up)….we have a zero % loan on a truck with 24,000 still owing for another two years. We do have a savings account of 45,000… We both receive a OAS and CPP each month ($ 2,600 total ) but unfortunately our truck payments are taking just about ½ of that…..we are doing our best to live on our pension incomes without taking too much of the savings each month 😊

My question is because of our age do you think  that we should pay the truck off now  out of the 45,000 saving account then we’d have the truck payment gone and have more income to do more with our lives while we are still reasonable healthy to do so….

We now realize buying that truck and tying ourselves up for 6 yrs. was a BIG mistake ☹ but the damage is done and horse is out of the barn…

 

OK, a few things first:

-This email hit me really hard and was rather depressing for a number of reasons.

-I’m sharing it, and talking about it, because it is not an isolated story, but quite common, and getting more so for a lot of seniors.

-The numbers have been rounded to not make it too complex to walk through.

-When I share the odd time that the $20 Money Tools book will save you a hundred bucks on literally every page, I KNOW this couple would never have made the truck purchase or likely have run up the credit line if they’d read either of those chapters first!

Good news: Everybody “sold” you and has made a bunch of money at your expense! The bank won because you’re in a huge financial trap. Your line of credit is a $90 interest only payment (at 4.7% and rising) and thus you’ll pay it for decades without ever paying off a dime. The car dealer’s 0 interest was likely the reason you got the truck at a payment of half your fixed income. They made the profit, and likely sold you some add-ons buried into the payment. So everybody did well…

Your good news is that you have a four-year old truck that will last another decade. You’re right – you can’t change the past, and it’s now worth less than half of what you paid, and likely worth less than you still owe. So love it, take care of it, and drive it into the ground. The other good news is that this is easy to “fix” to create some breathing room.

For anyone not on a fixed income, the fastest way to become debt free is to keep $1,000 in emergency savings and pay off everything else. (The Money Tools book “step up” plan)

In your cases, being retired and having a $2600 fixed income, I would do it a little different, and you have two choices:

1..Pay off the LOC from your $46,000 savings and reduce it to a $5000 limit (as an emergency account). Your savings may be 0.25% at most, so your LOC is NINE TIMES the rate and you’ll never pay it off. And that’ll go up with one or two more prime increases in the next six months to be 12 times the interest you make on savings.

That $90 saving isn’t much, but since it’s all interest, it’s a total gain. Then leave the truck at $1,000 payments for the next two years and subsidize your income from drawing down some savings. It won’t be much of a lifestyle, but there’s a fixed end in sight and zero temptation to “drop down” on how much you pay on the truck.

Option 2 is what I would do: You’ve worked too hard to not have some financial freedom, to go out for dinner the odd time, etc. to live on $1500 for two more years while you’re healthy. It’s stressful, because you have utilities, cable, truck insurance, food, etc. so there’s literally nothing left over – in fact, you’re using some of your savings each month just to tread water.

I would pay off the truck from savings today. Yes, you’re giving away (not getting the benefit of) the last two years of 0 percent, but the financial insanity of those payments will be over. That should or could stop dipping into savings to meet your monthly expenses.

The math says keep the zero percent truck and pay off the LOC but this isn’t purely about math with your situation.

That leaves the LOC. It’s $90 a month to tread water. Now to decide if that’s just going to be around for the rest of your life because of your fixed income, or whether you want to spend 10 to 15% of that income to get it paid off. That’s your call:

25 years to pay it off = 248 a month

15 years = 302

10 years = 372

5 years = 587

See now how the bank has won huge? There’s zero chance you can pay it off in any reasonable amount of time, so their total income (the interest total) is massive…and we all trick ourselves into just looking at the low rate… Even if you paid it off in 15 years, by that time they’ll have made about $12,000 in interest…90 bucks at a time…

You can’t use the rest of your savings ($46000 less truck payoff) leaves $22000 to pay off your credit line. You have to at least keep 6 months of your expenses a full emergency fund.

Spend $45 to Save $36,000

Two weeks ago, I received an email from a listener in Kelowna asking for some financial feedback. The email had enough in it to fill an hour or more, but here are the highlights:

This middle-aged couple has done really well in their investments. They have significant RRSPs and contribute 5% to their pension plan. They do have an RRSP loan at a good rate – and I won’t fuss about that.

They live within their means, no extravagant spending, small mortgage at a great rate, and an income of over $100,000.

On the debt side, it’s a different story. When they bought the Money Tools book at Mosaic, they immediately found $12,000 savings! Pretty good for a $20 investment! I keep saying: You go to almost any page and you’ll find a way to save money in whatever area! In their case, they have a line of credit that’s insured with life and disability. That’s one of THE biggest ripoffs in the financial field. The bank’s profits are 50 to 60%. Never get your insurance from the bank – ever. He immediately called to cancel it, but was on hold for 1 1/2 hours and never did talk to someone. Well, don’t bother calling. Write a three sentence letter that you want it cancelled as of today and deliver it to your branch. Banks can have a way of ignoring a call, claiming they never received it, etc. in order to protect their profit. In writing and delivered gets it done.

Their line of credit has been around since finances weren’t so good in the 1980s. It’s around $40,000 at a rate of over six percent! The rate is always prime plus something. That rate may have been OK when things weren’t so good, today it’s a massive overcharge. His credit score is over 780! He’s in the top 10% most credit worthy people in the country and ought to pay prime! 3% over for the last 10 years and on-track to only pay it off in another decade is over $25,000 in extra interest! All he did was go to equifax and pull up his credit score! When rates go up, lenders move up your rate. When your credit improves, they’re not voluntarily passing on a lower rate! You have to know your score and go ask – or demand it or fire your bank.

In the case of this couple, I wouldn’t move the credit line, but just get from the 10-year plan to one that pays it off pretty easily by Christmas this year. They have $20,000 in savings. Read the step up debt repayment section: First pay off your debts, then start saving. In their case, they should keep $5,000 for emergencies, dump $15,000 onto the credit line and pay $2,000 a month to get it done. It will take another six months to pay off the RRSP loan, and by June next year, they’d be debt free – instead of the 10-year payment plan they are on.

With a great income and getting really mad and motivated, they would be

$25,000 insurance cancellations for the 10 years the line of credit would take to pay off on their current plan

or: $25,000 (roughly) to pay off the line of credit 10 years sooner

$11,000 paying off the RRSP loan (the interest isn’t tax deductible) nine years sooner (by next summer)

That’s $36,000 of savings by spending $20 on the book and $25 on pulling their credit score. That’s a pretty good return!!

Then, next June to December, they can save the $500 they were paying on the RRSP, the $2,000 they were paying on the line of credit for six months or a total of $15,000 by just re-directing what they had been paying on their debts!

So-called “Good” Debt and Your Stay-at-Home Partner

BNN recently featured a Bank of Montreal survey with the headline that Canadians are taking on more “good” debt. Oh nice. So everything is fine – nothing to see here – move on.

Give me a break. I understand the logic of what they’re saying, but I disagree with the premise that there’s really such a thing as “good” debt.

The survey called borrowing for the purchase of a home, to do renovations, or for education good debt. Well – maybe. But most of these CAN be done with cash and without taking on more debt. The only exception would be the purchase of a home. But only in comparison to taking on debt for vacations or credit cards, as two common examples.

News flash: At the end of the day you still need to make the payments. It’s “good” if the rate is really low, bad if it’s the 20% credit cards. But debt is debt. It stops or reduces the amount you can save, because you only have a finite amount of net income. So, every time you borrow, you’re taking a voluntary pay cut: Same pay, minus the necessity bills minus one more new payment now.

It’s good or at least “gooder” if it’s a fixed loan where you have three, four, or five years and there’s an end. It’s never good when it’s interest only, such as a line of credit where the average person owes over $35,000 and owes it for more than 14 years. It may have started off with the sales pitch that it’s “good” debt, but when you add up all the interest and time to eventually pay it off, it was a horrible idea.

And one more thing, if you have a spouse who is a stay at home parent with your kids: A new study just found that a stay at home parent would be fairly compensated at $117,000. So if your partner is a full time parent, do not begrudge them their “me” money, or question their personal spending unless you want to pay them what they ought to get paid! You really need to read the Money Tools relationship chapter: When you got married, it stopped being  “your” money or “their” money and became “our” money.

Once You’re Debt Free…

I was super excited for a couple that someone met and asked to contact me. He told them to get in touch with me for some feedback on whether to use investment money to pay off their mortgage, or keep investing. That wasn’t the exciting part, though. Debt free but the home is something most people haven’t ever experienced in their life. If your home is also paid off, you’ve reached the pinnacle of financial success. But the critical hurdle is to have all the consumer debt cleared first.

This couple, at $780,000 actually become part of the richest one percent in the world. That includes your toys, cars, and equity of your home. Net worth is the total of what you OWN less the total of what you OWE. If you’re someone in that position, there are a few general things you should consider:

Close any line of credit you have. That’s especially true if it’s secured against your home. Once you have some net worth – stop borrowing forever. Don’t be tempted to just keep that line of credit in case…close it today.

Have one normal second credit card, but get an American Express card right from them with no monthly payments. A real charge card forces you to pay the balance in full every month. Close every other card but these two.

What’s you big reward for having won with money now? Maybe it’s a new vehicle every five years, perhaps it’s travelling, or now doing a ton of charitable giving. Set up a separate savings account and have money transferred into it automatically every month. $500, $800, or whatever accumulates automatically and pretty quickly to fund your well-earned big rewards.

Make sure your investments are conservative if you’re into your 50s or older. But do make sure they grow, and aren’t parked at a bank with really bad returns. Whether it’s $200,000 or $2 million – conservative investments should still yield you over seven percent a year before taxes! That will double what you have in the coming eight to 10 years!

If your investments do, or will, include rental property, make sure it’s with 50% down. Pay it down if you have one or have the 50% down if you buy one. Do not make a rental property the reason your finances crash. The risk isn’t worth the income. 50% down lets you sell it in a week no matter what the economy does.

Set up a full emergency account. Most people struggle with the first step of one week’s pay to get started. If you’re financially successful, set up a savings account with three to six months of all your expenses. That way you’re not breaking investments, cashing RRSPs, or using a line of credit in an emergency. If you need big car repairs or a new roof, it’s no longer an emergency, but only an inconvenience.

If you still have a mortgage, it’s time to get serious about paying it down or paying it off. You may just want to write a cheque for the balance and then re-direct what you were paying a month back into your investments. Plan B would be to pay 10% extra each year, cut the leftover term down, and change to weekly payments to cut another four to five years off the time left. You have the money – now just increase what goes on the mortgage.

Lastly, pay it forward. Make sure the kids of friends, your nieces, nephews, grandkids, or families in your church or elsewhere get to learn the lessons you know AND that you live: Put some money into savings each month, live on less than you earn, and learn the difference between needs and wants. Oh and if you care enough to share: Got to Mosaic and get someone a copy of the It’s Your Money book. They may not listen to you but maybe they’ll read a chapter or two…

An Easy Way to Save $8.400

There’s a very happy lady in Vernon now. A couple of months ago she applied for a $20,000 line of credit. She was approved, but at a rate of prime plus three percent. She was smart enough to take a time-out and tell them she’d think about it. She was right not to sign up. The rate should have been prime, or prime plus one at worst. When she emailed me, it was really easy to see why her rate was this high.

She has a credit card with a limit of $8,000 and a balance of $5,000. When the balance is more than 50% of the limit, it plummets a credit score. Since the rate on her credit line is only based on that score, she was told prime plus three.

The fix was easy, too. To get a little better rate, she just had to pay down her credit card below 50% of the limit, so a payment of $1,100 to get there. To get a boost on her credit score, the balance versus limit has to be below 30%.

There were two ways to accomplish that: I had her call her card issuer to increase her limit. She did that, and had it raised to $10,000. A higher limit meant her balance versus limit dropped automatically. Now it was $5,000 owing versus $10,000 limit less her $1,100 payment. Now she just had to make another $600 payment to get her card balance to less than 30% of her limit.

She waited 45 days to get it through her credit report and went back to her financial institution. Presto! They re-did her credit report and just like that, she was re-approved at a rate of prime. Since the average person owes on their line of credit for 14 plus years, that was a saving of $600 a year times 14 years, or $8,400. Not bad for one little detour!

Don’t just roll your eyes, complain, and think there’s nothing you can do. Just don’t sign up on the spot. You don’t walk into Walmart and pay double for something, do you? Why would your borrowing rate be any different?

And if you already have a line of credit that’s over prime, the same thing applies. Some lenders check your credit score once a year and adjust your rate – others just do it once. If you’re line of credit rate went up, don’t just shrug your shoulders. Go ask how many points your credit score has to move up! Then get your credit card balances below 50% if they’re not – below 30% if you can and ask them to re-calculate your rate or get another lender!

While You Weren’t Looking Your Credit Card Charges & Rates Went Up!

As I keep saying: What happens in the U.S. will come to Canada. This time, it’s a massive increase in credit card penalty interest rates. It was announced last week by the CIBC and TD that, if you get behind on your credit card, they’ll jump the rate – a lot!

It’ll increase by up to 15%. That’ll put a low rate credit card of 12% or so to upwards of 27%. And it used to be for six months – now you’ll be in the penalty box for a year at that insane rate. If you play with fire, you’re going to get burned. Credit cards are a great convenience but they’re not your friend. If you carry a balance, low rate 12% cards are a bad rate, 20% normal cards even worse – but 27% is insane. And who pays them? The people who can least afford the penalty rates, because they have a hard time making the minimum payments. Don’t charge today what you can’t pay off by the end of the month. Whatever you’ve bought on your credit card isn’t worth paying for years at close to 30%.

The second bank change, this one on lines of credits and credit cards, also has to do with your credit rating – your credit score. You’ll see a ton of rates that are now “prime plus.” When rates go up, your rates will go up right with it the following month. On the TD website, their Emerald credit card is now prime plus 1.5% to prime plus 12.75%. If you apply, you don’t know what your rate will be when you get the card in the mail. It might be low or insane. That totally depends on your credit rating. Reason number 238 to go to equifax.ca and purchase your credit score. If you don’t understand it, email it to me and I’ll explain it, or go to yourmoneybook.com for the US Fighting Back! book. It has a huge section on credit scores…something Americans all know and live and die with. Us Canadians better get to learn it, too – it’s coming to Canada right now!

We’re Going Broke At a Slower Pace

Newly released averages from TransUnion, one of the credit bureaus shows what we talked about recently. We’re increasing our borrowing, but at a slower pace. Great. Kind of like someone on a diet just having three pieces of cake, instead of four. We’re still growing our debts which are already significantly too high.

On average we owe $3,600 on our credit cards. But remember that about half of Canadians pay their balance in full – hurray. So the rest of us owe over $7,200 – and that should be a concern.

Lines of credit are now over $35,000 on average. But think back not that many years ago. We used to get a personal loan if we wanted to borrow $10,000 for renovations or $15,000 for a motorcycle. Well, making a loan costs the bank about $200 to $300 in setups, credit reports, etc. So they moved us to lines of credit. Now a loan had a three, four, or five-year term of fixed payments. Make all the payments and you were done with this debt. Yet, a line of credit makes us the loans officer. We can pay as little as interest only (newsflash: Most do) or as much as we want. We were sold on convenience and hardly anybody gets an actual loan these days, with the exception of vehicles. Now we can pay as little as we want and the banks don’t have to keep making new loans.

The downside is that now, on average, we take more than a decade to pay off our lines of credit. That’s assuming we don’t just roll them into a mortgage refinance. It used to be four years of loan interest, now it’s a decade or more of payments. Great for the lenders, very bad for us. Without much of a rise in incomes and all the other monthly payments, it’s just natural to fall back on the least amount we can pay – and we do.

Banks really do have the brightest marketing minds in the country. They’re so great at selling us something that they make a profit on and helping us with our going-broke plans.

What Matters More: Your Rate, Balance, Term or Payment?

Quick question: Would an extra $4 a month really rock your world in a big way? There’s a new radio campaign out from one of the no-service banks: Switch your credit line to us and save half a percent in interest. Plus, the guy in the commercial says he now sleeps much better and worries less.

OK, that’s stupid. If you don’t owe anything on your credit line, the rate doesn’t matter at all. If you owe $10,000, a half percent interest saving amounts to $4 a month. That’s going to help you sleep better and worry less? Even with a $20,000 balance, it’s a lousy eight bucks a month saving! Hello?

The ad may sound great, but shouldn’t get anyone excited. We get ourselves into a big financial mess with two things: Focusing only on the rate or purely the monthly payment.

When it comes to borrowing, there are four things you’ll need to know:

The balance or total amount you’re borrowing
The interest rate
The term of the loan – how long you’ll owe the money
The payment per month

The payment is the least important factor. Sure, it has to fit your budget, but you can pretty much have any payment you want – you just have to stretch the term to a really long and stupid time period. A car can get financed for three years, or up to seven years – your call, your interest, your pain – if you’re not careful and don’t ask!

The rate only matters if you owe a lot of money AND you owe it for a long period of time. You’re better off owing $5,000 at 20% for a year than owing $5,000 at 6% for a decade! The faster you pay it off, the less the interest matters since the debt isn’t going to be around for long!

That leaves the balance, or the total amount you owe or borrow. THAT is the most important factor. News flash: If you don’t borrow anything – the rate doesn’t matter and your payment will be ZERO! Want to guess how many foreclosures, collections, repossession or legal actions happen to people who don’t borrow money? NONE – that’s right!

If you can lower what you owe, borrow less, get a little less expensive renovation or car, take some of your savings as a down payment, or any one of a dozen other ways, THAT controls everything.

Focus on what you are paying and not what you’re saving. Focus on the balance and not the rate! Four bucks a month is not the issue, it’s the payment of $300 or so, the balance you owe, and the fact that your line of credit likely has your entire house for collateral!

A Common Financial Trap We Do to Ourselves

At least three times in the past few weeks I’ve heard a common financial strategy from people with a bunch of debt: I’m going to transfer it from my credit card to my line of credit because the rate is so much less.

Yes, but no: If you believe that the interest rate matters a lot, and that your debt is about math, you’re sort of right. Sure, transferring something from 20% to 6% might be a good idea. But getting into debt, and out of it is, not about math. It’s almost all about psychology. If it were about math we wouldn’t use a 20% credit card, or buy a new vehicle that has dropped $3,000 to $5,000 in value before we get it home!

Remember that transferring your debt around is NOT the same as paying it off. All you’re doing is shuffling it from one place to another, none of which accomplishes a thing in the total amount you owe.

If you owe the money on your credit card, you’ll be way more motivated to pay it off, exactly because of the high rate. If it’s transferred to a line of credit, that motivation goes down the drain. If you do it – fine. But in two years, look back on the math and add up what you’ve paid in total. I’d bet, for most people, it’ll actually cost more since we stretch out the repayment forever.

When we transfer this $1,000 or so, it also pays down our credit card. Hurray – now we have another excuse to use our credit card again because the balance is gone. We tell ourselves the balance is paid off, but forget that it’s just owing in a different place. But six months down the road, the credit card is run up again and we STILL owe the transfer on the line of credit. That makes things worse – way worse than leaving it on the credit card and focusing on paying it off.

I’m not even dealing with the fact that we still think debt is our friend and haven’t wanted to separate our wants from our needs. That has to be true, or we wouldn’t have charged this amount, but saved the money first. Then we can buy whatever it is and actually afford it!

It’s a vicious cycle that credit card companies and our line of credit lender love to assist us with, and keep us in forever. And we’re more than willing to play the game. But it comes at a very high cost in a number of ways.

Break the cycle. Buy it when you can afford it. And if you ignore that advice, which you will, leave it where it’s owing, and get on with paying it off as quickly as possible. That will be quicker, less costly, less likely to run up the credit card again, and less stressful.

Save or Pay Off Debts?

Two weeks ago I had an e mail from a listener asking if her and her husband should pay off their $30,000 line of credit, will still contributing $400 to their RRSP each month, or to stop contributing, and focus on the debt? Unfortunately, there’s no black or white answer, and the note didn’t have any information about their income, tax bracket, etc.

Paying off debts is way more of a psychological and emotional issue than it is about math. If it were about math, who on earth would be dumb enough to run up debt on a 19% credit card? Who would finance a vehicle that depreciates so quickly AND adds thousands of dollars of interest on top of something that’s worth less each day?

That’s why I generally advocate stopping your investments while you clean up your debts. It’ll make it go that much quicker, and you get the huge self-confidence that you’re making progress each month.

There’s also no better return than getting out of debt. With a 19% credit card, you’re paying after-tax money. The chart to walk you through what your rates really mean is in the It’s Your Money book. So, that 19% card is really costing you 27%. And there isn’t a reasonable investment on the planet that’ll make you 27%.

The issue is a little different when it comes to a line of credit that’s likely in the 4 to 5% range. It’s also different for someone who has a substantial income and can pay off their debts within a year or 18 months.

If this couple is in a high tax bracket, the RRSP savings will net them a great tax return that should then go on the PLOC immediately. So essentially, half the investing is still going onto debt.

If they stop the RRSPs, it’s only for a year or so. It’ll give them way more traction, save a bunch of interest, and get it done two years faster. But that depends on whether they are really committed to paying off the balance in the first place.

Lots of people kid themselves that a line of credit is no big deal, because the interest is so low (forgetting it’s after tax money, that rates have already gone up ¾ of a percent, and often that size line of credit is secured by their home, and they keep using the line of credit…)

Anyone who is making some pretty steep payments on their debt anyway, and is seriously committed to getting debt free should absolutely stop investing for one year, and get their debts paid off and closed. If it’s going to take two or three years, it’s your decision: Get debt free fist, or just reduce your RRSP contributions for a while.

Whatever you do, this week, you need to do a written budget of where your money is going, and I bet you can find $100 to $200 in your budget that’s leaking out right now, and can go to the PLOC without you even noticing much of a lifestyle change at all.

When we focus on saving and paying debts and this and that, we know none of these will get done with much intensity. When we have a single-minded focus to pay off one or two balances, you’d be amazed how quickly it happens. If we want to…