Listen to the podcast Smart Ways To Pay Off Debt
Doug: Welcome to Debt Free in 30, where every week we talk to industry experts about debt, money and personal finance. I'm Doug Hoyes.
When it comes to paying off debt, there are both good and bad ways to tackle the problem. Should you use your RRSP, take out a consolidation loan, ask a friend to cosign a loan or do something else? Should you make a deal with collection agencies? I ask my guest today if these options are good idea and I’m going to ask for advice on how best to pay down your debt and become debt free. So let’s get started. Let’s bring in my guest. Who are you and what do you do?
Leigh: Hi, my name is Leigh Taylor, I’m the president of LC Taylor. We are trustee firm in Winnipeg and Northwestern Ontario. We're in the business of solving problems. We are Trustees in Bankruptcy because that gives us more tools, but basically we deal with people and their problems to find solutions.
Doug: Great, well thanks for being with me here today Leigh. I'd like to draw on your years of experience to get your take on as many different issues as possible. So we are going to move quickly and cover a lot of ground today.
So to start, last week on the show we talked about whether it’s better to pay down debt or invest in an RRSP. That was show number 32. So if any of our listeners missed it you can hear it on our website at Hoyes.com, that's h-o-y-e-s.com, or you can download it from iTunes or whatever podcasting app you use on your phone.
So you are a Bankruptcy Trustee, you've helped thousands of people over your career. So I would like to start by getting your perspective on that issue. Specifically, I would like you to tell me is it a good idea to cash in your RRSP to pay off your debts?
Leigh: Generally speaking, no, and lots of good reasons for that. Maybe the first one is that RRSP’s are generally exempt from seizure in financial problems. So if you went bankrupt or are being sued or whatever nobody is going to be able to take your RRSP’s. And that's a good thing. Another reason is that RRSP’s are designed for long-term goals. You are someday going to want to retire and you are going to be a little disappointed if all you have is CPP and old age security to retire on. It doesn’t keep up with inflation and you are going to be hard-pressed unless you have some extra money put away. So basically, you're going to be drawing down your future to try to solve today’s problems when there are better solutions. -
Doug: Let me just interrupt you there and pick on a couple of those points before you go on. So you said exempt from seizure. So if you go bankrupt, you don’t lose your RRSP’s. It’s as simple as that?
Leigh: - That's right. I was going to say there is Federal and Provincial legislation and most provinces have similar legislation to deal with the Federal legislation. So generally speaking, wherever you are in Canada, you’re going to have an exemption for your RRSP.
Doug: Okay so in Ontario your RRSP is exempt except for what you put in in the last year.
Leigh: Right. In Manitoba it's exempt completely.
Doug: It is exempt completely. Okay so there is a very key difference between two different provinces. So in Manitoba, if you go bankrupt, you’re not losing your RRSP, no matter what. In Ontario, if you go bankrupt, you lose whatever you have contributed in the year prior to bankruptcy. So that's what we mean by exempt from seizure.
Okay so I interrupted you in the middle of that. So continue on with your list of why it’s not a great reason to cash in an RRSP to pay off debt.
Leigh: Sure. As soon as you cash in an RRSP you are going to have a hefty tax bill. And the way the tax act works is that the income or the money that you got out of your RRSP is included as taxable income. That's going to be on top of what your regular income is, so it is going to bump you up in all likelihood, to a much higher tax bracket. And you could find out that you could have to pay tax on as much as 50% of the money that you withdrew. So you take your money out of your RRSP, you pay off some debt with it to only find out that at the end of the year, you end up with a big hefty tax bill. You really haven't solved your problems.
Doug: You find out at the end of the year because when you go into the bank, or wherever to cash in your RRSP they're only going to take off, I think it is a maximum of 20%. But like you said, if you happen to be in the 40% tax bracket when you file your taxes, the government is going to say "oh guess what, there is still another 20% you haven’t taken off". So you think you have solved your problem and really what you've done is traded one debt for another. You end up with a big tax liability.
Leigh: That’s right. The other problem that people often run into is that they think well I’ll take out some of my RRSP money and I’ll pay off the creditor that is giving me the hardest time. And that doesn't really work either, simply because if you're not going to have a solution that solves you that problem, you don’t have a solution. Solving half of that problem doesn't get you very far. So unless you can solve your debt problems that is not much of a solution.
So there are, I suppose, exceptions to every rule. There is always the danger in too much generalization. Some people have cashed some of their RRSP to help them through things like proposals, etc. They've used it to make a deal with their creditors, when they are compromising the debt and these sorts of things, and notwithstanding that you are going to have to pay tax on some of it. That may not be a bad idea, but it depends on your particular situation. Most of the time, by far, the majority of situations we’ve come across where people have cashed in RRSPs, it has not accomplished what they wanted it to accomplish. So generally speaking, bad idea.
Doug: So let’s say I walk into your office and I say look, I don’t make a huge amount of income I make enough to survive; I don’t have any extra income. I have got $50,000 worth of credit card debt and they are hounding me and bugging me and threatening to garnishee my wages. And I've got $20,000 in my RRSP. That's my only asset. So what I’m thinking of doing then is cashing in my RRSP and using it to pay the debt, but obviously the math doesn’t work. I have $20,000 in my RRSP and I have $50,000 in debt. So at most, I’m going to get $20,000, and of course I won’t get that much because some of it goes to taxes. So you are saying that’s probably not a good idea to cash in the RRSP. What are my other options then?
Leigh: Well you have to do the math on this thing. The first choice is not to cash in your RRSP. It is possible to file a proposal with your creditors, a consumer proposal, whereby your offering to pay them X number of dollars based on your ability to pay a month over a period of time, which could be as long as five years. And if that works for you then oftentimes these kinds of proposals are quite acceptable to creditors. The other option is where you can’t afford the cash flow. You don’t have a few extra hundred dollars a month to make it worthwhile for them; bankruptcy might be the option.
You’ve got to take the solution in your own context. How old are you? You know if you are 23 years old and you have 40 years of working life in front of you, using some of your RRSP money probably makes more sense than if you’re 58 and you might have a few good years left. You want to save up those RRSP monies. So cashing in a few dollars in RRSPs to save your financial situation can vary depending on your particular circumstances. You've got to look at that very carefully. I’m not a proponent of cashing in RRSPs at all.
Doug: And so what if I’m a young person and same scenario. I have $20,000 in my RRSP and I have $50,000 worth of debts. If I cashed in the RRSP maybe I end up with, I don’t know, 10 or $15,000 depending on my marginal tax bracket. Would there ever be a case where you would suggest using that money to do a lump sum proposal?
Leigh: Yes, sometimes it makes a lot of sense to do it. It has to solve your problems though. It has to be such that you make a proposal based on the trust condition that the RRSP will be cashed in. The net amount after taxes can be used to make a lump sum payment to your creditors and resolve the financial problem at that point in time. It depends on things like whether bankruptcy is going to affect your employment status or whether it’s going to affect any other aspects of your life. So that all has to be taken into consideration. And at that point in time, you really have to sit down and talk to an expert that is going to be able to go through the details and give you a clear option as to what's in your best interest. Often that's not the best answer, but in some cases it can be.
Doug: And I guess that is really the point. There are number of nuances here. So, in most cases you are not a big fan of cashing out an RRSP for all the reasons you just laid out for us. It is probably exempt if you had to go bankrupt anyways. You’re going to get hit with a tax liability and so on. But there may be cases such as I’m a relatively young person, I've got a lot of debt, I have some money in my RRSP’s. Perhaps by cashing it in, paying the tax, and then using the net amount to fund a lump sum consumer proposal if the creditor has agreed; take care of all my debt, don’t have to worry about payments. That would be a specific circumstance where it may make sense. But, like you said, a lot of different factors to consider here. So professional advice is the way to go on that. That's pretty much the summary then?
Leigh: I think that’s it, yes.
Doug: Excellent. Well that is a good summary on whether it makes sense to cash in an RRSP to pay down debt or whether you should use extra money to continue to invest.
I've got a bunch more questions for you. So what I’d like to do Leigh, is take a quick break and then we will come back and talk about cosigning loans and debt consolidation and debt collectors, and whatever else we can get to. So we're going to take a quick break and we will be right back here on Debt Free in 30.
Announcer: You're listening to Debt Free in 30, here's your host, Doug Hoyes.
Doug: We are back here on Debt Free in 30. I’m Doug Hoyes and my guest today is Leigh Taylor, who is a Bankruptcy Trustee with LC Taylor and Associates. And I’m guessing the firm is named after you Leigh? Is that where the LC Taylor comes from?
Leigh: Yes, it started out with just me, but we have expanded a little bit.
Doug: So there are more Taylors now involved in LC Taylor.
Leigh: There are more trustees involved, put it that way.
Doug: More trustees, there you go.
So before the break we were talking about, you know, some strategies toward paying down debt. What are your thoughts when it comes to cosigning a loan? So, I come to you for some advice Leigh and I say look, you know, my brother, my son, my neighbour or my relative wants to get a car loan, a mortgage, but the credit isn’t quite good enough to do it without a cosigner; so I'm considering cosigning for them. What should I be thinking about when it comes to that decision?
Leigh: Well I think the first thing to understand is what cosigning actually means. What the financial institution is saying is that they don’t think you are good enough credit risk without somebody else guarantying it or cosigning it. And what they're basically are saying when they cosigning something is, if he can’t pay it I will. And that’s really what it comes down to. People don’t always understand what they are saying and they often think that they are vouching for the honesty or integrity of the individual. They are conscientious and hard-working of course they are going to pay it off.
I think the reality, though, is that that doesn't necessarily have anything to do with it. In reality, the traits really are good traits, but you get into situations with unemployment, illness, marriage breakup, natural disasters, and a whole myriad of financial traumas that can happen. It will result in financial difficulty. And that financial difficulty may mean that the cosigner is going to be called upon to pay the debt. So it really means as a friend or relative, if you can’t afford to loan them the money yourself, then you probably shouldn’t be doing it; because that is basically what you’re doing.
Doug: So if I cosign a loan, I am fully liable for that loan.
Doug: If the original borrower doesn’t pay; the primary borrower doesn’t pay, I am fully liable for the whole thing. And I guess that’s really what you’ve got to have your mind before you cosign for somebody else.
Leigh: Yeah and the sad part – the saddest part is when the individual that is in financial difficulty has a mother or his best friend cosign for him and then he comes in to find out what kind of solutions are available for his financial problems, whether its proposals or bankruptcy or whatever. Only to find out that the cosigner is not relieved of their liability just because you go bankrupt. So now what happens, instead of going bankrupt on a bank or a financial institution of some sort, you’re going bankrupt on your mother, you know, who loves you dearly and only has a house and a very small pension to live on. And suddenly her future is going to be jeopardized because of your unfortunate situation. And it may not be your fault as such. The reality is, is that most people that end up in financial difficulty find themselves there for a number of reasons, some of which are beyond their control.
Doug: So you really have to look at both sides of the equation if you are considering cosigning a loan for somebody else. The question to ask yourself is would I just loan them the money right now. And I guess if I’m cosigning a $10,000 loan for a friend of mine who needs to qualify for a car loan, and I've got $100,000 sitting in my bank account, okay, no big deal if you can’t pay. The money is sitting there, not a problem. But if I don’t have a cent to my name, cosigning a loan can get me into - get me into serious trouble if my friend isn’t going to pay. And the flip side, which I hadn’t thought about until you mentioned it, is me asking someone to cosign for me, is putting them in a vulnerable position too. So I’m assuming you're not a big fan on either side of the equation. Either asking for a cosigner or being a cosigner is something that should be avoided unless you have lots of dollars in your jeans. Is that your position?
Leigh: That’s right. Unless you need a loan for open-heart surgery for your kid, I can’t see too many justifications for going after a cosigner.
Doug: And you have dealt with people in your career who have cosigned for someone. The original borrower was not able to pay, and that threw them over the edge?
Leigh: It’s like dominoes. One goes bankrupt, the next gets called upon and they end up in financial difficulty and it goes right down the line. So you really have to be careful. It’s a dangerous practice.
Doug: So avoid it if you can. So ok, let’s hit on another topic here, because were talking today about smart ways to pay off debt. I would assume a debt consolidation loan is a good way to go. If I've got a whole bunch of credit cards and I’m paying a high interest rate and I can consolidate at a lower interest rate, is that a good idea?
So two questions for you - what is debt consolidation? And is it a good idea?
Leigh: Well again people don’t understand debt consolidation. It’s sort of a two edged sword as well. People somehow mistakenly think that one payment of $1000 a month is more manageable than 10 payments of $100 a month. Slightly more convenient, but that’s about it. You really have to look at things like interest rates. When people look for consolidation loans, it’s usually because they’re having trouble financially and they're trying to do something to alleviate the situation.
If they've got a bunch of credit card debts they can’t pay off and they go to a financial institution - a high risk lender, let’s say, and that lender says I well I will give you a loan and consolidate it. It isn’t necessarily going to be a lower rate of interest. It may be over a longer period of time sure, but the interest rate generally speaking, is going to be higher because you are a higher risk.
Now the other side of the sword as I was saying is that if you had short-term debt, let’s say a bunch of credit cards, and you’re paying somewhere between 18 to 22% interest on it, it might be wise to roll that debt into let’s say a second mortgage if you've got some equity in your house. You could probably roll it into a second mortgage for somewhere around 6 to 8%. You can spread the payment of that mortgage over a number of years. Sometimes second mortgages can go for 15 years. And what that does is it reduces the amount of interest that you’re paying on it. It can be then be that you pay it off quicker, because what you save on interest you simply put back in to cover the principal again. By spreading it over a number of years you can create a solution to the cash flow problem. You just don’t have enough money to pay the short-term debt every month and it can spread that out over a period of time. And that can solve a financial problem.
Now, the problem oftentimes related to that is people don’t change. The lifestyle habits that they created, spending habits etc. that got them into the difficulty and created a whole bunch of credit cards oftentimes doesn’t change so they end up with a consolidation loan. Now, they find that they have some extra money left over every month because of the cash flow improvement, and they don’t change their spending habits. All too often we see people that went through the consolidation route, only to end up four or five years later with a bunch of credit cards again, maybe the same ones. And now they have a bunch of credit card debt at 18 to 22%, plus a consolidation loan that has been going on for four or five years, and they find themselves pretty well strapped without too much of a solution other than bankruptcy at that point in time.
Doug: So the consolidation loan treated the symptom. It didn’t treat the problem.
Leigh: Right. So unless you really get into the good budgeting and financial management to keep you out of debt and put you back on track. The consolidation loan has done very little except just put the problem off for a couple of years.
Doug: So the answer to the question then, should I get a consolidation loan is number one, deal with the reason you’ve got all this debt to consolidate. And that could mean proper budgeting, cutting your expenses and so on. And then once you've addressed the underlying problem, then yes a consolidation loan may make sense, but then it becomes a math question. What interest rate are you going to be paying? Over what period? So in those cases, if I've dealt with the underlying issues first, then it perhaps makes sense to get a consolidation loan, if it’s affordable. Is that your position?
Leigh: That makes a lot of sense.
Doug: Okay cool. So final question I want to ask you, and we’ve got about a minute or so here. So, debt collectors. You have heard about them. I’m sure. And this is probably one of the main reasons someone would show up in your office; I’m getting all these calls from various different debt collectors and again, we're thinking of smart ways to pay off debt here. Is it a good idea to make a deal with a collection agent or debt collector when they're calling you for money?
Leigh: Well what you have to do is you have to look at the whole problem. If you are in a financial situation where debt collectors are contacting you; if you just got one debt and they are collecting, then you can probably deal with that one debt. They often will accept lump sum payments rather than over a period of time. A lump sum payment this week will probably solve it. You have to be really careful. First of all, you have to be able to afford that, which means you probably have to go out and get more money, borrow it, get it in some way shape or form, but you also have to get it in writing. You can’t just make the deal over the phone send them a cheque and expect them to go away, because as often as not, they’re going to come back and say, well, that was the first installment what about the rest of it. So you've got to be really careful with that.
Doug: So it’s okay to make a deal with the debt collector if it’s affordable; if it’s a debt you really owe and if you get it in writing that you have fully paid off the debt. Otherwise, you’re asking for trouble. So that's a very good way to end it. I appreciate you being with me here today, Leigh. Thanks for being here.
Leigh: It was a pleasure, Doug.
Doug: Great thanks, Leigh. We're going to take a quick break and come back to wrap it up right here on Debt Free in 30.
Announcer: You're listening to Debt Free in 30 with Doug Hoyes, we'll be right back.
Doug; Welcome back. It’s time for the 30 second recap of what we discussed today.
My guest today was Leigh Taylor, who had lots of great advice on smart ways to pay off debt. He’s not a big fan of cashing in your RRSP and taking the tax hit to pay off your debt. And debt consolidation only makes sense if you can reduce your expenses and avoid debt in the future. That's the 30 second recap of what we discussed today.
I agree with Leigh's points. There are many ways to become debt free, but the best strategy would depend on your unique situation, including your age, amount of debt and type of debt you owe. That is why Leigh suggests getting professional advice and I agree that a free consultation with a debt expert is a great place to start. That's our show for today.
Full show notes are available on our website including links to many of Leigh's videos where he discusses in more detail many of the topics we discussed today, so please go to our website at Hoyes.com, that's h-o-y-e-s.com for more information
Thanks for listening. Until next week, I’m Doug Hoyes. That was Debt Free in 30.
Let's Get Started Segment
Doug: It’s time for the let’s get started segment here on Debt Free in 30. I’m Doug Hoyes and my guest today is Leigh Taylor. And we are talking about different ways to pay off debt and deal with debt, which brings up the question, Leigh, if you have debt does that mean you are a bad person? Maybe more specifically, if you have debt that you can’t pay back, and you're considering doing a proposal or a bankruptcy does that make you a bad person? What are your thoughts on that?
Leigh: No, I don’t think it does it all. People get into debt for all sorts of reasons. Most of them are to some degree beyond their control. The normal kind of debt load that you might have can be exacerbated by loss of employment, illness, marriage breakup all kinds of things - that financial traumas that face all of us, from time to time. The test I suppose as to whether you are a good person more so is what are you going to do about it.
Part of the problem is, all of our mothers in this country have taught us when we were very young that if you borrow money, you pay it back. And that seems like a pretty solid lesson to learn. The thing our mothers didn’t teach us though is what do you do if you can’t. There is no way that you are going to be able to repay this debt, for whatever reason; what do you do about it at that point in time?
You know, there's legislation. The Bankruptcy Act has solutions depending upon your situation. You have a choice about what kind of solution you want. There are non-statutory solutions with respect to budgeting with compromising debts, and these sorts of things. There are lots of resources available to most people. The question is, if you find yourself in financial difficulty, running and hiding doesn’t help. Telling your creditors, when they phone, they’ve got the wrong number or whatever doesn’t really work either. So facing up with the realities of the situation and finding a solution that’s the mark of a good person I think.
Doug: So it’s kind of like - you know you’re talking about our mother’s here and yes, you’re right. That’s the way they raised us. They also told us to brush our teeth and take care of ourselves, but occasionally you get a cavity anyways. And the solution, I guess, is not to pull all your teeth out or jump off a bridge. I guess the solution is to deal with it. I've got to go see a dentist, and I have to deal with it. It’s really the same thing here isn’t it? I have to look at how I got into this situation, but then I’ve also got to look at ways to get out of it.
Leigh: Yes, there are lots of honourable solutions for honourable people with debt problems.
Doug: And so of the people you deal with, and you have been in this business a few years. Would you say that most of the people who come into you who end up needing to file a bankruptcy or a consumer proposal are crooks who are really trying to gain the system? Or are they generally speaking, good people who, as you say, for reasons somewhat beyond their control, got in over their heads.
Leigh: By far the vast majority are pretty average people. Nobody’s perfect. They make mistakes. Sometimes they get a little bit carried away on their credit card debts, fully intending to pay it back. But some financial problem comes up, you know, they had to go to a funeral in Vancouver and there is their spare money is gone. And then they ended up losing their job or getting laid off whatever. These sorts of things happen. So they're pretty good people. You’re not going to look at them and say, well, they went bankrupt. There is something morally unacceptable in their attitude or behaviour, because that’s just not the case.
And the reality of it is, is that with the advent of and changes bankruptcy in the last 30 to 40 years, I would be very surprised if everyone out there didn’t know somebody (friend or relative) that has been through financial difficulty, and they resort to a proposal or bankruptcy or whatever. They don’t generally advertise it so you may not know it, but I would be surprised if you didn’t know somebody.
Doug: No, you’re right. Because if you look back, I mean we’re recording this in the spring of 2015 and I think in 2014, there was something around 118,000 people in Canada who either filed a personal bankruptcy or consumer proposal. And if you go back to the credit crisis in 2008 the numbers were closer to 150,000. So over the last 10 years, it’s well over 1 million people in Canada who have gone through this process and there's only 35 million of us. A bunch of them are kids or people who are no longer working. So when you look at the working age population, you’re right, it’s not an unusual thing to happen. So it's something that happens. And so your approach then, dealing with someone who is feeling a bit guilty about this is what? How do you walk them through that then?
Leigh: Well I think they have to realize that consumer credit is a two edged sword. It can be very dangerous if you don’t deal with it properly. And if you let it get out of hand, it can hurt you and people around you. On the other hand, consumer credit is what - really is the main factor in what keeps our economy going. The rotation of dollars through the economy is how they measure the strength of the economy. So if it wasn’t for consumer credit, you wouldn’t be able to buy a car unless you saved up for it for example. And if you could only buy a car if you saved up for it, you can imagine how many new cars there would be on the street. There goes the tire industry, the gas industry and the repair industry, etc. etc. So, the economy really does depend on the use of consumer credit.
Doug: So we just have to use it properly and not get into trouble with it. Well that’s a very good way to end it. I think what you’re saying Leigh, is credit is a tool, it’s not either good or bad, it’s just how you use it. Thanks for being with me today.
Leigh: My pleasure.
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