Tag Archives: line of credit

Save or Pay Off Debts?

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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…

Feedback on Your Questions

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Over the next two weeks, we’ll answer some of your e mail questions that are certainly topical and questions that thousands of others have, as well:

Your question: I enjoy listening to your program on 1150. We may have a very large amount of money coming in soon. My question is: Do we buy a place and pay off the mortgage completely, or put some of the money elsewhere?

First and foremost, remember that I only ever give feedback on what I would do. But there isn’t a lot to go on here. I assume there aren’t credit card balances, lines of credit, or car loans. If there are, consumer debts are first, paid off from smallest balance to largest.

Then I want you to have a three month of income emergency fund in a simple savings account. That’s not to be touched unless it’s a real emergency.

Next, make sure you have your RRSP, or Tax Free Savings Account, maxed for the year, depending on your tax bracket, etc.

When you ask about buying a place, I’m guessing you mean investment property or your own home. If it’s your place – yes. And you can pay cash for it, which is the dream of 99% of home buyers. Do it! There is nothing like a free and clear house.

If it’s investment property, the hard rule is to have at least 50% down. Then you are in a position of strength, and not risking it all, AND the 50% down means you’ll always be cash flow positive.

Your question: My investment of $30,000 recently expired, and is now sitting in the bank at 1%. We do not want to tie it up again as I am in my late 70s, and want it available if needed. Could you advise us as to what is our best option? We are on a limited budget and this is our savings. We do not have any mortgage and we have a line of credit of $40,000, but it was for a family member, who is also paying it. Our monthly income is approximately $2500.00.

While I’m not an investment advisor, you don’t need one. That $30,000 is almost all of what you have. Take the lousy 1% the bank is paying and know that it’s risk free. Rate = risk, so a higher return means you’ll have to take on more risk. And you’re late middle age, so it’s not worth it.

I don’t like the $40,000 line of credit at all. It’s a floating interest rate, and that’s already hit you for half a percent and climbing. I like it even less that a family member used your credit to borrow. Today they may pay, but what happens when they don’t? And please don’t kid yourself into thinking that won’t happen. Please!

You need to protect yourself first, because nobody else will do it for you. Do two things right away:
-Have a heart to heart talk with this relative and get them to refinance it out of your name or pay it off – NOW.
-Immediately move your $30,000 nest egg to a different bank than the line of credit is at. All the documents you have signed state that they can just take your investments and use it to pay off the debt you owe them – period. Do not risk your entire life savings on a relative. Never, ever. I won’t even talk about the big problem that this relative should never have come to a late 70s person to sign a loan and that you should have said no.

Go to another bank today and transfer the savings. Then have a face to face with your relative that the time to just make interest-only payments is over. Please!

Learning the Painful Lessons of Others

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I had a great phone call last week from a radio listener. After we talked, I realized there were a bunch of things in the call that are huge lessons for all of us:

The caller shared that she and her husband were two years away from paying off their mortgage. As I was heading for the fridge to pull out some champagne, she volunteered that they also had a $100,000 line of credit.

Stop! What? OK, let’s not kid each other here. That means they’re a long way from a mortgage burning party. The line of credit is secured against their home – it counts! Kind of like saying we’re debt free except that $8,000 Visa balance. Nice try…

This couple is also planning to retire in a few years. But that means no more paycheques and a big switch to a fixed income. What happens then? Most of us drop back to paying interest only on these horrible lines of credit and that means it’ll never be paid off!

Those circumstances describe a large number of people in a very similar situation, so let’s look at three points:
-First – combine the first mortgage almost done with the line of credit. TODAY! Credit lines are variable rate and change every month. The next rate waves are up up and away. Take the amount you’re paying on the two right now and put it into any on-line calculator. In this case, it’s about $120,000. Take a fixed rate less ¾ percent and plug in the current payment to get the term. In other words, don’t take a 10 year mortgage and drop the payments. Take the payment and make the term work.

-Make that payment as high as you can possibly afford and that should give you your retirement date. Because then you’ll be ahead of the game $1500 or $2000.

-Have the payment and term before going to your credit union or bank. Don’t let someone tell you, “well, you should add a cushion of $10,000” or “you should stretch the mortgage so you have some cushion.” Bullcrap – you’re being sold so get out or tell them to get real: on a longer term or more borrowing. That’s NOT what you want and you’re in control!