Listen to the podcast about What's The Right Way To Consolidate Debt
Doug H: Welcome to Debt Free in 30, the show where every week we talk to industry experts about debt, money and personal finance. I'm Doug Hoyes.
So, you've got a bunch of debts. You owe money on three different credit cards, and a payday loan and you still owe some money on an old cell phone bill. You've got a job and you've got money coming in every month, but it's hard to juggle five different debt payments every month all on different days in addition to all of your regular bills. Wouldn't it be great to consolidate all of your debts into one monthly payment? No more juggling your pay cheque to make a bunch of payments every month, you would just have one easy monthly payment. Sounds great, right? Debt consolidation does sound great and in some cases it is a good idea. Other times not so much.
Today on Debt Free in 30 we're going to talk about debt consolidation; the pros and the cons, the good and the bad and the ugly. A few weeks ago the guest on my show was Leigh Taylor and I asked him if debt consolidation was a good idea. Here's what he had to say.
Leigh T: People somehow mistakenly think that one payment of a thousand dollars is more manageable then ten payments of a hundred dollars a month. It's 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 cards they can't pay off and they go to a financial institution, a high risk lender let's say and that lender says well I'll give you a loan and consolidate it, it isn't necessarily going to be at a lower rate of interest. It may be over a longer period of time, sure, but the interest rate is generally speaking is going to be higher because you're a higher risk.
Now there are - the other side of the sword as I was saying, is that if you have short-term debt, let's say a bunch of credit cards and you're paying somewhere from 18 to 22% interest on it, it might be wise to let's say 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 then be that you pay it off quicker because what you save on interest, you simply put back in to cover the principle again.
By spreading it over a number of years you can create the 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 often times 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, then they end up with a consolidation loan, now they find 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 to end up with a bunch of credit cards again, maybe the same ones. And now they've got a bunch of credit card debt at 18 to 22% plus a consolidation loan that's 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 H: So, the consolidation loan treated the symptom, it didn’t treat the problem.
Leigh T: Right. So, unless you really get into the good budgeting and good 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 H: So, the key point here is that before you consider signing up for a debt consolidation loan, you have to ask yourself an important question. Why am I in debt? The answer of course is because you spent more than you brought in, that's the real issue. So, will getting a debt consolidation loan solve your budge problem? No, it won't.
So, you've got to address the cash flow issue first. If you're in debt because you were out of work but now you're working and have a good job you may have already solved your cash flow problem so a debt consolidation loan may be a good way for you to lower the interest rate you're paying and get back on track. But if you're in debt because you have a fancy house and expensive car and you go out for dinner at expensive restaurants five times a week, a debt consolidation loan will not solve your problem, it might buy you time, but it won't help you reduce your debt. You have to deal with the underlying cash flow issue first.
So, let's assume that you dealt with the cash flow problems and your budgets in good shape but you have some high interest rate credit card debt that you'd like to deal with. You want to replace your high interest credit card debt with a lower interest rate debt consolidation loan.
We all know that the lowest possible interest rates are on home mortgages. Banks are willing to give you a good deal on a mortgage because it's secured by a house. If you don’t pay, they take the house. So, they're almost always guaranteed to get paid. It's low risk lending, so you get a better rate. So, is getting a mortgage a good strategy as a debt consolidation loan? How does it work? What kind of deal can you get? To find out I'm joined by a mortgage expert so let's get started. Who are you and what do you do?
Mark M: Thanks Doug. My name is Mark Moreau. I am licensed mortgage agent for Ontario. I've spent the last 30 years in financial services working for many of the major banks, working for some of what we call "B" lenders.
In the past I've written policy for the major banks as well as run the sales for nationally at all sorts of things. Right now I'm, as I said I'm a licensed mortgage agent so I deal with a number of lenders in Ontario including banks, all the way through to the private lenders. So, my approach is enter a situation, try to figure out what the customer's needs are and try to figure out what the best solution for them is. And because I'm a mortgage agent I've got lots of flexibility and lots of options available.
Doug H: So, we're talking about debt consolidation and re-financing. So, what does it take? Explain to me what does it take to re-finance my house, to borrow some more money so I can pay off some existing debt?
Mark M: Well, the starting point is really around where you are in terms of debt, where your credit history is and all those sorts of things. So, we'll start with the simplest one. We'll start with the "A" borrower. And the A borrower is classified basically as a bank borrower, right? So, you've got clean credit, you've got an income, you've got all those wonderful things. Those kinds of restructurings are fairly straightforward and easy in general. The things that you require are pretty much all the same all the way through.
On the other side if you get a customer who's got some damaged credit or perhaps some fudged credit, then you've got a different situation altogether. It's still possible and a lot of opportunities and a lot of flexibility there but there is a slightly higher need for more documentation and certainly more checks and that sort of thing. The biggest difference between those two though is that, to your point earlier, the banks like to lend to the borrower. So, that's why they lean towards the low risk customer who's got great credit history, has got the income and everything else.
The B lenders focus more on real estate. So, they focus first on the security. So, that's a good news and a bad news story because those lenders will do some things that are outside the box for an A lender which in the case of somebody who is really credit challenged gives them more opportunities and a lot more flexibility then I think people really know about.
Doug H: So, that's a key point then. An A lender, which or I guess an A client can go to a bank.
Mark M: Yep.
Doug H: And the bank says how much income do you have? We're looking at you specifically whereas if perhaps I've had some challenges in the past, I've gone through a bankruptcy or proposal, I've got a whole lot of debt, then the bank, not so eager to look at you. You're then going to a different lender who is going to place more emphasis on the value of the real estate their going to be financing. Is that what you're saying?
Mark M: Yeah in essence that's it. So, it goes back to what I said my approach was initially. So, what we generally do is we'll take a look at the client's situation. And wherever we can get the client the best deal and by best deal I don’t just mean rate, I mean in terms of what actually can be done to help them in their situation? That's where we'll go to it. As I said we've got lots of flexibility. The banks will stop generally at 80%. CMHC as an example, will not do credit restructuring kind of deals but we got these other B lenders that that's their playground, that's where they're going to like to go.
Doug H: Well, I'd like to hear how all that stuff works. So, what we're going to do is take a quick break and then we're going to come right back here with Mark Moreau on Debt Free in 30. And figure out exactly what does it take to get a re-financing done. We'll be right back.
Announcer: You're listening to Debt Free in 30 with Doug Hoyes. We'll be right back.
Doug H: We're back here on Debt Free in 30. I'm Doug Hoyes my guest today is Mark Moreau and we're talking about debt consolidation and more specifically debt consolidation when you're using your house as collateral.
So Mark, I want to throw at you a scenario here. So, let's assume I'm sitting in your office right now and I tell you that I bought my house a few years ago and it's gone up in value and I just had local real estate agent tell me it's worth $400,000. My mortgage is $250,000. I've got $50,000 in credit card debt I'd like to pay off. So, what's it going to take for me to borrow $50,000 against my house so that I can use the money to pay off my debt?
Mark M: Well, Doug the starting point for all of this is the house itself, obviously. So, even though a real estate agent might have given you a value, one of the first things I ask to be done is we have to get the house appraised. And just to establish that $400,000 is the appropriate amount or the value of the house at that time. Because all of this lending is really driven off of ratios, the amount of debt to the value of the property.
Doug H: So, just on the appraisal then. So, how does that work? Who do you use to do that? Do I have to arrange it? What's that going to cost me? How does that work?
Mark M: Well, appraisers, there's a number of appraisers in every community as well as some national organizations as well. It's really determined by the lender that you're going to use. Some of them are very adamant as to which appraisers get used, that sort of thing. But in general it's very, very quick and easy. The work is on my side of the fence. I'm the one who orders the appraisal. Once I've determined where we're going to go with the loan, because certain appraisers fit certain lenders and certain ones don’t, as an example. In general you're looking at a price tag of about $250 to - I've seen them as high as $350 for residential mortgage, but when you get up into the higher end that's usually because they're rural properties or -
Doug H: Something more complicated.
Mark M: Yeah investment properties as an example. So, if you've got a multi unit, if you've got a four plex that sort of thing you got rental income then there's a little more work required by the appraiser.
Doug H: And is that something that I would just pay directly for? Is that how that would work then?
Mark M: Yeah. In terms of brokering and in terms of getting that re-finance, whether you're talking to a bank or whether you're talking to a broker such as myself is that's the one piece of work that has to be done upfront before we can actually move forward with anything. Whether you've got great credit and you're moving forward or whether you've got fractured credit, we still have to start with the house. Now that's the only upfront cost that's involved in general with any of these kinds of transactions.
Doug H: Okay, so the first step is the appraisal. You're going to bring someone in, figure out what the house is worth. What happens next then?
Mark M: Well, just working off of the scenario that you gave me in this case if you take the $250 plus the $50,000 in credit card consolidation. Let's assume that the house is worth $400,000 that $300,000 is 75% of the $400,000. So, the next step is determining what's the profile of the client? Do they have good credit? Do they have bad credit? If they've got good credit this is pretty straightforward and easy. We can go to a regular bank or we can go to really a mortgage bank. So, they operate and have the same rates and similar products as the regular banks do, quite frankly. Those are pretty straightforward.
The advantage to working with somebody like me though is that quite often I can actually get you a better deal and a better rate than you can get through the branches. If you're - and on the other side of the coin, you've got a B client and by B we've already determined that's what we mean, so we're in damaged credit area (not necessarily damaged credit but we're in a tougher spot). Then at that point we've got the same process basically. So, we've got to get the appraisal done and then we've got to find the appropriate lender.
Doug H: And so the appraisal's done. So, in the scenario I gave you, it's pretty simple.
Mark M: Yep, pretty straightforward.
Doug H: Cause you said it was a - it's going to end up being 75% loan to value. Meaning the mortgage at the end of the day is 75% of what the property's worth. So, let's make it more complicated then. Let's say it's a higher number than 75%.
Mark M: Yeah, again the first question is, what's the condition of the customer's credit? So, A credit you're pretty good to go 80% or even above that.
Doug H: So, 80% and what's the magic about 80%?
Mark M: The magic of 80% really stems from the Bank Act. So, banks under the Bank Act are required to not lend above 80% percent without having a mortgage insurer in place.
Doug H: So, let's talk about mortgage insurance then. What are you talking about there?
Mark M: Well mortgage insurance is really insurance protection for the lender. So, it protects them against default on the mortgage. So, many, many years ago, banks, within the Bank Act, determined that banks can lend on their own volition up to 80% of the value of the property. Once they go beyond that they can still lend, but they have to get an insurance policy in place. And those insurance policies are provided by, predominately by CMHC, a company called Gen Worth or Canada Guarantee.
Doug H: So, there's three companies, the biggest one being CMHC and if I'm not mistaken CMHC is actually me, right? Cause that's a government of Canada thing and so it's really my money that's supporting that I guess.
Mark M: All of our money, yes.
Doug H: All of our money. Yeah, I guess I'm not the only tax payer in Canada.
Mark M: If you will take that on I would be happy. [laughter]
Doug H: No, no I can't afford this country let me tell you. So, if I'm re-financing my house, if I go over 80% loan to value, the lender has to have insurance either from CMHC or Genworth or whomever.
Mark M: Just let me clarify that a little bit. If they are a bank, an institutional lender that has to abide by those rules, so either the Bank Act or some of the other trust company acts and that sort of thing, a Credit Union is an example, then they're forced by law to impose that insurance. Private lenders, mix, some of the secondary lenders don’t have to have that insurance in place, but they'll do their own kind of self insurance. So, when you take a look at the two, it's really comparing different kinds of apples, but they pretty much operate the same way.
Doug H: So, if I was a really rich guy and I had millions of dollars and I wanted to start a mortgage company, I could do that.
Mark M: Yep.
Doug H: I could loan to whoever I wanted, I wouldn’t have to have mortgage insurance. But realistically like you say I'm going to price it accordingly then. And so as a consumer you'll probably end up paying something similar to it one way or the other, I guess is what it comes down to.
Mark M: Yeah, basically if we can just take a little bit of tangent here, when you have to get mortgage insurance in place, it's done on a premium basis which is a percentage of the total amount of the mortgage that's going to go out. That premium gets added to the value of the mortgage.
So, in this case we said $300,000 when you add the fees you're going to have a mortgage that's going to be more than $300,000 because the insurance premium is going to be in there. So, when you're talking about CHMC and - let's just stick with a purchase for a second cause it's a little bit cleaner, the rate of fees is between .6% and goes up to roughly 4% right now or 3.5%, somewhere in that range. When you're in the B market, the fees, or the premiums rather are pretty similar. Now they don’t necessarily call them premiums, they're going to call them fees, lender fees, that sort of thing. But you're within a point or two of that so they're pretty comparable, quite frankly.
Doug H: Got you. So, 80% is the maximum if I'm re-financing my house. What if I'm buying a house brand new?
Mark M: Well let me just correct something there. 80% isn’t the stopping point. 80% is the stopping point where you need insurance.
Doug H: Okay.
Mark M: Okay, so if you've got really clean credit and you want to re-finance beyond that then we can get it done at a bank and we can get it done with CMHC insurance on it. If you're doing a debt consolidation though, so you've got some fractured credit and it is really, we're trying to clean up a mess, then CMHC will stop. They don’t do default management situations on their insurance, but all the B lenders do.
Doug H: Got you. So, what's the maximum I could go to then in that scenario? So, let's say fractured credit but I have a house with equity in it. I can go over 80% you're saying.
Mark M: Yep.
Doug H: And can I do that with a bank through CMHC or am I pretty much with a B lender at that point?
Mark M: Again, it comes down to what is the - if it's a self imposed debt consolidation as an example, if you've just decided that you've got too many credit cards, you want to address the situation but your credit's in great shape, then that kind of debt consolidation is really just an equity take out. And we can get that done at almost any bank.
If however you're under pressure, so you've got some delinquency on your accounts and those sorts of things and you're getting calls from creditors and that, people of that elk, then you're in a different category. So, there are limitations on whether or not we can go over that 80% with CMHC or Genworth or Canada Guarantee in place.
Doug H: So it is possible, it's certainly not guaranteed. So really what you're saying is it's a lot easier to borrow before things get really serious.
Mark M: Yeah, I mean that's the end of the equation is that. I mean you sort of led into it before, is the time to get this under control is before it becomes a problem, quite frankly.
Doug H: And under those scenarios it is possible to get decent rates, decent values but once you've got lots of judgments and things on your credit report, it's going to be a whole lot more difficult.
Mark M: Yeah, it's well, it's going to be more difficult, let's put it that way. So, going back to your original question, if we're in that category then we slip into what I call the B market, in that case we can go, actually I've seen some deals go 100%, but not very many but you can comfortably get to 85, 82, 85 and even up to 90. I just recently did one that was 90%. With capitalized fees takes us slightly over that.
Doug H: Which I guess is why - that's why you deal with a mortgage agent, you're able to shop the market, find the best deal and help people get the deal that they need. So, I appreciate that.
We're going to take a break and come back to wrap it up here. My guest today was Mark Moreau. You are listening to Debt Free in 30.
Let's Get Started Segment
Doug H: It's time for the Let's Get Started segment here on Debt Free in 30. I'm Doug Hoyes and today my guest is Mark Moreau. We're talking about mortgages and debt consolidation. There's a lot of new things out there, Mark. Why don’t you tell me about some of the new products that you're seeing in the mortgage market?
Mark M: Well, there's lots of offer out there, Doug. One of the big pushes by a lot of the banks and a lot of the lenders right now is for secured lines of credit. And they come in a couple of different flavours; either there's a straight up line or credit or they come as sort of a blended multiple product offering. So, some of those have a mortgage component so the mortgage that you and I would understand and know. So, it's got a term and a rate and all that kind of good stuff.
But attached to that is a line of credit. What people don’t really understand is that the banks do this for a couple of reasons. First of all it gives customers ready and easy access to the credit, that's the good news. The bad news is, there's a whole bunch of other implications that come along with that, that I'm not entirely convinced that people understand. And certainly when I see customers that are trying to get out of - work out situations and trying to correct situations there's a few gottchas and surprises that can jump up and bite you.
Doug H: So, let's think this through then, if I go in and get a conventional mortgage we all pretty much know how that works. There's, you know, pre-payment penalties but there's also some good things too. I can take that mortgage potentially with me when I buy another house.
Mark M: Correct.
Doug H: What are some of the gottchas then when you're talking about - what amounts to really a secured line of credit instead of a mortgage? And a line of credit sounds good to me, right? Cause that means I can borrow against it, I can pay it down, it can go up and down. With my mortgage, I'm making a set payment every two weeks or every month.
Mark M: Yep.
Doug H: It's not changing. And yes, maybe once a year I can pre-pay 10% or whatever I negotiated but it's basically a loan until it's paid off. Whereas with a line of credit if I want to borrow some more I can, if I get a tax refund and I want to pay it down I can. That sounds fantastic to me. Why shouldn’t we all just go out and get secured lines of credit instead of conventional mortgages?
Mark M: Well, I've always taken the approach that it's not a one size fits all kind of a product. Certainly with the lines of credit and even these multiple component products are good for certain people, they've got great incomes and the ability to repay and that sort of thing. But buying a car over 30 years cause you use your line of credit against your house doesn’t make a lot of sense to me.
Doug H: I would agree with that.
Mark M: The other piece of it too, is that on the line of credit component, the interest calculation is entirely different than it is on a conventional mortgage. They're ever so slightly different but it's simple interest. And the rates are a heck of a lot higher. They're a little bit veiled because of the way the presentation is but the way that the actual rate is calculated is a little bit higher than a conventional mortgaging.
The real danger that I see though is twofold, or maybe threefold, is that you get in a situation where you're kind of using your house as an ATM. So, instead of the old world where we used to pay our houses down and we get to age 60 and we've got no more debt against the house, it's part of our retirement package, that's great. But with lines of credit what we're starting to see is a trend that the house never really gets paid off. So, that's one issue.
The other issue for people who are doing a refi that they have to be aware of is that although lines of credit generally don’t have any pre-payment penalties, the real gottcha is in the way that these things are registered.
So, you tipped on it just a little bit earlier you can take a conventional mortgage and if you don’t like your lender or you wake up tomorrow morning and you decide well, there's a better rate someplace else or they've done something horrible and I just want to change banks, that's fairly straightforward and easy with a conventional mortgage. When you have a line of credit, because it's registered differently you actually have to discharge that. So, you got higher legal fees. And then you have to go to the new bank and register a whole new mortgage. So, they can be quite expensive.
Doug H: So, I could end up paying literally thousands of dollars more if I want to get rid of this line of credit that I've got and move it to somewhere else?
Mark M: Yeah, it all comes down to what your lawyer's going to charge you. But you've got an additional cost that you wouldn’t necessarily have with a conventional mortgage. So, that's one of the gottchas.
And the other one too which I think is a big one is the fact that most Canadians don’t pay them down as much as they just reuse them. So, over time that can be a great strategy if you're inclined to pay more heavily than you borrow.
Doug H: So, you really have to look at yourself and say hey if I'm naturally a saver, I want to get this paid off as quickly as possible, then it might not be a bad idea because then you can pay as quickly as you want. But if you're the type of person, if there's access to money there I'm going to use it then you'd be better off with a conventional type mortgage where there's a payment every month and it eventually gets paid down.
Mark M: Yeah, that's my personal opinion. It really comes down to this, what do you use the money for in my opinion. So, if you're going to use it for depreciating assets like cars and other -
Doug H: Vacations.
Mark M: Yeah vacations, that sort of thing, probably not the highest and best use.
Doug H: Yeah.
Mark M: If you're taking that money and reinvesting it into a rental property or other investments, that sort of thing that will give you a return, then it makes sense for folks that are inclined that way, but not for every Canadian.
Doug H: So, there's no right or wrong answer; you've got to really evaluate your own situation. But be careful there are as you say some gottchas that you've spelled out for us. So, in our final few seconds here, give me a quick overview of somebody that you have helped.
Mark M: A client came to us, they've got an old CRA arrears situation so they owned some back taxes, had some other challenges with some other credit cards and that sort of thing. Really we needed to get to 90% to help them out. So, it took quite a bit of doing but we were able to help those folks out. They will get back on track, so that one’s going to have a happy ending at the end of the day.
Having said that, it doesn’t come cheap either, so it's sort of like, the analogy that I use is like going to the hospital, if you've got a client who's seriously injured, you take him into emergency into triage, you stop the bleeding right away; and that's kind of the situation. In a couple or three years their credit should be back to where it is and then we can push them back into a regular bank, cheaper rates and all that kind of good stuff.
Doug H: So, even in that scenario there are solutions, but they don’t come cheap. Great. Thanks for being here today, Mark.
Mark M: Thank you.
Doug H: Thank you. That was the Let's Get Started here on Debt Free in 30.
Announcer: You're listening to Debt Free in 30. Here's your host Doug Hoyes.
30 Second Recap
Doug H: Welcome back. It's time for the 30 second recap of what we discussed today.
On today's show we talked about debt consolidation loans. Leigh Taylor explained that one monthly payment in a debt consolidation loan is more convenient then making multiple payments on multiple debts, but it only makes sense if you can negotiate a lower interest rate.
My second guest, Mark Moreau, explained how it's possible to get a debt consolidation loan by borrowing against the equity in your house. But there are limits on how much you can borrow and if you have less than perfect credit, your monthly payment will be higher than it would be for someone with perfect credit. That's the 30 second recap of what we discussed today.
So, what's my take on using the equity in your house to consolidate your debts? You can finance more than 80% of the value when you're buying a new home, but on a re-financing it's much more difficult to borrow over 80% with a conventional bank. So, unless you have sufficient equity, re-financing your mortgage may not be a debt consolidation option.
So, if you want to re-finance your house the first question will be what's the house worth? And that question is answered with an appraisal. And as Mark said the bank will tell you which appraiser to use and you're paying the cost.
If you do have sufficient equity in your house to re-finance, the next question will be whether or not you can afford the monthly payments. If you can’t afford it or don’t qualify, re-financing your mortgage is not the correct option. And that gets us back to what Leigh Taylor said if you have too much debt, the most important step is to change your spending habits so that you can start paying down debt.
And that's the most important point. Debt consolidation does not reduce your debt. All it does is replace one set of debts for another. Your total debt remains the same. It may be a good option but only if you can reduce the interest rate you're paying, and only if you can keep your budget balanced going forward.
That's our show for today. Full show notes are available on our website including information on debt consolidation. 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.
Announcer: Thanks for listening. This was Debt Free in 30.
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