Decreasing Debt Loads, the Wolf in Waiting

The Wolf In Waiting

Let's go house shopping! 

If there is one thing I have heard too much of in the world of finances is that Canadians have an insanely high debt ratio. Very few people care about this. Mainly because they aren't in the financial industry. But I'm here to tell you every time there is a news story about the Prime Rate, Bank of Canada or Canadian Real Estate bubble there is usually a caveat about how much the average Canadian is in debt. We have heard it so much we have tuned it out, much like the phrases 'historically low interest rate' or 'continuing war in Afghanistan'. In effect, we are being trained (conspiracy theorists can submit theories in comments) to ignore that little boy who is crying Wolf. Nobody is telling us to stop spending money. In fact, it's the opposite. We need to keep spending money to keep the economy in motion. It's why it has 'never been easier' to qualify for financing that new house, car, big screen television. It's why Black Friday has become a North American institution; more important to Americans that Thanksgiving.  

Excluding mortgage debt, the amount an average Canadian is in debt is is roughly $20,000. PER PERSON. If you are married with one house, that means chances are you and your partner are currently $40,000 in debt - excluding your mortgage. The majority of that being most likely credit card debt, student loans and car loans. And real estate isn't the only industry flashing the yellow caution sign in regards to consumers being overextended.   

An apt metaphor of what to decide to pay off first...

So what can you do?

First of all; you have to be aware of what you are looking at in terms of your finances. Your income coming in has to be able to pay for what you are putting out. If it doesn't, that difference is usually made up with your credit cards. Visa, Mastercard, American Express and an increasing number of specific store only cards earn more profit with the interest they charge and rely that you will (or actually won't) find a way to earn more money to pay off those cards. It's why stores/car dealerships offer 'no-interest' for a year or 0% financing. 

'We can get your application approved with one phone call.'

They are gambling that you won't have changed your current spending habits to pay off that debt before the grace period is over. So you are left staring that extra payment straight in the mouth, trying to figure out where you are going to come up with an extra $200 a month.  

Hello, your no-interest term has expired.

Here are 2 options I can help you with if you are currently in that 'average' range of debt owing. These are taken directly from the Financial Consumer Agency of Canada website. 

1. Refinancing

Some mortgage lenders offer their customers refinancing options. This allows home owners to access the equity they have built up over time. Refinancing may involve changing the terms of your original mortgage agreement, and the refinanced portion may have a different interest rate than the original mortgage. You may have to pay fees in order to do this.

You can borrow up to 80 percent of the appraised value of your home, minus the amount left to pay on your first mortgage.

Example:

Louise is planning a home renovation project and is looking at refinancing her home to fund the renovation. Her house is currently worth $200,000 on the real estate market, and she still has $100,000 left to pay on her mortgage. Her mortgage lender calculates her credit limit for refinancing as follows:

Appraised value of home:​ $200,000
Maximum loan allowed:​ x 80%​
Loan amount based on appraised value:​ = $160,000​
Less balance owed on mortgage:​ – $100,000​
Refinancing credit limit: ​ $60,000​

If the lender and Louise agree to refinance her home to the $60,000 limit, she would owe a total of $160,000 on her mortgage.

Now, this doesn't necessarily help her pay off her debt unless she has already made these renovations. In which case, with valid receipts they would be considered in the overall renovation. 

For instance; you've already paid Home Depot $10,000 for a new kitchen. You are about to start paying 18% interest on the balance you have yet to pay off. Why not apply to your lender for refinancing at a much more reasonable rate between 3-5%?

One other catch; the lender may wish for you to pay for an appraisal of your home's current worth - estimate that to be about a $300-400 fee.  


2. Home Equity Lines of Credit (HELOC)

A home equity line of credit works much like a regular line of credit. You can borrow money whenever you want, up to the credit limit. You can pay it back and borrow again. You have to apply for a home equity line of credit to find out whether you qualify.

The Office of the Superintendent of Financial Institutions (OSFI) has issued guidelines for federally regulated lenders such as banks that address the maximum amount for HELOCs. OSFI expects federally regulated lenders to limit new HELOCs to 65% of your home’s appraised value. A HELOC can be combined with a regular mortgage for a maximum of 80% of your home’s appraised value.

Example:

Nicole would like to get a home equity line of credit to use for a home renovation.
Her house is currently worth $200,000 on the real estate market, and she still has $100,000 left to pay on her mortgage.
Her mortgage lender calculates her home equity line of credit limit as follows:

Appraised value of home:​ $200,000
Potential maximum for HELOC and regular mortgage combine, based on appraised value (maximum 80%):​ = $160,000​
Less balance owed on mortgage:​ – $100,000​
Maximum credit limit on HELOC: ​ $60,000

Note: as Nicole pays off more of her mortgage, she will be able to borrow additional funds with her HELOC, up to a maximum of $130,000 (or 65% of her home’s appraised value of $200,000).

Note that a HELOC isn't 'renovation specific'. You can use that credit line to pay off your car or student loan or your credit cards. In theory a HELOC should help you lower your overall debt burden by decreasing the amount paid in interest to the smaller debts. 

Some people will also use a HELOC to make a balloon payment on their mortgage, paying down the overall principal owing which in turn decreases the length of the mortgage and the amount paid in interest over the mortgage's lifetime. 

Hope that helps anyone who may have been confused about the possibility of acquiring more debt to lower their debt owing. Any questions, contact me for a free consultation.