Borrower’s Remorse

Two recent client situations led me to write this blog. There is a myth that is perpetuated that financial success is achieved by choosing the right investments with a good return.

That is untrue. Your own financial behavior will have a greater effect on your outcome. Nowhere is this more true than in the realm of borrowing and lending.
Canadians are the most indebted citizens of the G7 countries according to the latest Stats Can report. For every dollar of income Canadians have at least $1.60 of debt. We are more indebted than Americans were in 2008 before the start of the financial crisis.

Lenders have made borrowing cheap, easy, and attractive. Along with societal peer pressure to have the newest and best, attitudes towards borrowing and carrying debt, and high prices for any major purchase can have a not so happy ending. Canadians need to learn more about borrowing.

Most people are familiar with how a mortgage works. Within the last decade variable rate mortgages have become popular. However, as interest rates have increased it would be wise to plan further than the next year or 2. Variable rate mortgages work best when you have extra money to pay the principal before or when rates rise.

It is the line of credit(LOC) that can trap borrowers into a never ending cycle of indebtedness. A line of credit is an on demand loan. In theory, the lender can ask you to pay off the entire loan anytime. They would probably never do that as they profit handsomely from collecting the interest on a loan that may never be repaid.

The borrower has options as well, having the right to pay off the entire loan at any time, unlike a mortgage. Lines of credit offer flexibility in payments unlike a mortgage. As long as the borrower pays the minimum interest there is no requirement to pay more. They are often very easy to get especially if the line of credit is unsecured. Unsecured means there is no collateral against the loan. For that privilege your will pay a higher interest rate, and that interest rate is calculated more frequently than a mortgage. This can become a debt trap where a large amount becomes harder to repay. It is called revolving debt for a reason!

The problem with borrowing money is that the borrower only focuses on the monthly payment they can afford and not the total interest cost. Lenders are loath to correct that tendency because if you the borrower knew the total interest cost you would never enter into the agreement. The interest cost can exceed either the amount borrowed, and/or the values of the purchases made with the borrowed money.

Secured lines of credit have higher limits because the collateral is your house. Recently one of my client couples was offered a LOC for $150,000, when they had requested less than a third of that amount. They were smart and used a little 3 word phrase: No thank you. I suggest you go to the mirror and practice that sentence, as good preventative financial planning. They told me the bank was mystified why they didn’t accept: “You can take it you don’t have to use it.” “Precisely why we don’t want it.” they said. I was proud of them that they had remembered and applied the advice from our discussions of the past.

I have seen maxed out LOCs where the only way the borrower will get out of debt is to do something drastic like sell their house, or something even worse. The problem is debt creep, you borrow from the LOC a little at a time until it becomes a huge unmanageable number that you don’t want to look at or deal with.

Remember that only making minimum payments and owing close to, or the maximum you can borrow will hurt your credit score.

Recently I helped a client walk through the process of refinancing a line of credit and her mortgage. She had used the LOC to buy a car. I don’t blame her with the price of car financing. I am sure you have noticed that the most attractive financing is on a new and expensive car. But with a salary that hadn’t risen significantly in 3 years, she had to do something. In the end I got her to negotiate a better deal. That was very gratifying work to me, when I used my extensive experience and knowledge to empower her to get a better outcome.

And here is the second exercise I would strongly suggest you do which will take less than a minute.

Ask yourself; How old will I be when I am debt free? Don’t say something academic like my mortgage/LOC/car loan will be paid off in x years. Nah that is an theoretical number devoid of meaning. If you say I am 48 and my mortgage is going to be a minimum of 21 years I will be 59….

Let’s practice some financial preparedness. Don’t let life just happen to you.

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