The Danger In Thinking Money Is Free
Today I talked to my business partner and the co-founder of Hoyes, Michalos & Associates, Ted Michalos. He offered his opinions about the way things have been going and outlined several predictions for the coming year, touching on important financial topics such as the economy, unemployment, and interest rates.
Taking A Look Back
In 2008 we experienced the fallout from the credit crisis. As a result, the number of personal bankruptcies filed in Canada hit an all time high of over 150,000 in 2009. At the same time, the Bankruptcy and Insolvency Act (the law that governs all bankruptcies in Canada) was revised.
Ted explains that,
the government made it more expensive, more complicated, and longer for someone to find relief from their debts.
Where most bankruptcies ended in 9 months, the government changed the rules so those households earning above a certain threshold (known as surplus income) would have their bankruptcy automatically extended to 21 months. To avoid having a longer bankruptcy, many people quickly filed under the old rules, causing even more of a spike in bankruptcies in 2009.
Enter The Consumer Proposal
Ted explains that the 2009 changes to the BIA made consumer proposals much more attractive. Where we once saw three bankruptcies for every proposal, today the ratio is even, with one proposal for every bankruptcy.
the reason bankruptcies are down is because more people are taking advantage of the consumer proposal solution.
Money Is Free And Perception Is Everything
Even with the growing popularity of consumer proposals, total personal insolvency filings are way down -- almost 22% from the peak in 2009. A lot of this has to do with the economy in general, and interest rates in particular.
Ted explains that right now, people are benefiting from low interest rates. People can refinance their home, borrow money to buy a car or take out a personal line of credit and the cost is pretty low so they are able to carry more debt than they could before.
Ted's concern is that this is building a perception that money is free. Eventually interest rates will rise -- you can't have free money forever.
One area where this perception is particularly concerning is the trend towards very long term car loans. People are getting themselves into trouble based on the assumption that they can afford their payments, but just like with the subprime mortgage crisis, it's a bubble that isn't sustainable.
Let's look at an example. Bob needs a car but he can't afford to finance on a 4 or 5 year term and he definitely cannot afford to buy the car outright. When inquiring about his options, Bob is offered an 8 year financing term at a price that he can afford. Of course he takes the deal because the lender is offering to give him the car that he wants at a steal.
The Catch? In 5 years Bob still owes $9000 on his car loan for a car that is now valued at $6000 and the value is only going down from there. It takes too long to pay off enough of the loan for you to owe less than the car is worth. Long term car loans provide the illusion of "free money" because they offer quick and seemingly affordable solutions that mask the bigger picture.
Low interest rates and the shift to lines of credit and long term car loans in recent years are reasons why Canadians are now carrying debt equivalent to 163% of their disposable income. Ted's concern is that many people are swapping lines of credit for credit card debt and extending their terms, rather than paying down debt because today at least, debt is so affordable.
Ted's Predictions For 2015
Bankruptcy numbers for 2014 have not yet been released, and won't be until March or April. However, based on personal experience from this past year, expectations are that 2014 personal insolvency levels will be similar to 2012 and 2013.
Overall 2015 will look a lot like 2014.
- Interest rates will likely stay the same for a while but are expected to begin to increase slightly in the fall of 2015 or early 2016.
- Unemployment may rise slightly, but not enough to affect bankruptcies just yet.
- Bankruptcy rates will remain unchanged as well for at least the next year.
Better Understand Your Finances In 2015
While in the short term we can expect the status quo for the Canadian economy in general, for those with debts, there is a risk that they will not be able to absorb the financial cost of even a small rise in rates.
The start of a new year can be a great time to get a fresh start and make a plan for the year, especially when it comes to your finances. Take a closer look at what kind of rates you are paying for things like your car or home and pay attention to the market to know when you may need to make smart changes. For example, know the difference between a callable loan and a variable rate.
- Callable: loans that can be collected at any time, with little to no notice.
- Variable: a loan that changes with the market.
While Ted predicts that variable rates should be stable for the next 6 months, it is important to keep an eye on the markets for any increases that might be set to take place, because even a half a point increase will lead to an additional $50 a month for every $100,000 that you owe. So if you are already stretched thin to make your monthly payments, you might want to consider your variable rate and whether you could survive financially if the rate increases even a half a point. If you can't, Ted suggests that it might be time to lock in your rate. He explains that by locking it in,
...you've made sure that when the rates do go up - and they are going to go up folks, there's no way to get around that - that you don't suddenly get hit in the side of the head.
Take Control Of Your Financial Future
Debt problems don't just vanish and piling on more debt is never the solution. Don't use low interest rates as a quick fix for the situation that you might be in because they seem like "free money". Creating one debt to pay down another only creates a cycle that never seems to end. Instead, use low interest rates as an opportunity to pay down your debt. That way, when the rates do go up (and Ted has warned us that they WILL go up), you have created good habits. Furthermore, Ted suggests that,
...if you're carrying more debt than you can deal with, then you need to talk to somebody, a professional that can help you sort it out.
Make 2015 the year for your fresh start. Know the numbers, make a plan, get the help you need and make it happen.
Resources Mentioned in the Show
FULL TRANSCRIPT show #18 with Ted Michalos
Doug Hoyes: Welcome to Debt Free in 30, where every week we talk to industry experts about debt, money and personal finance. I’m Doug Hoyes.
This is our first show of 2015, so let’s get the year started by answering two questions, what’s going to happen in 2015 and what should you do about it?
First some background. We all remember the credit crisis of 2008 and that led to the highest number of personal bankruptcies ever filed in Canada in 2009 at over 150,000. It wasn’t just the credit crisis that caused that massive spike in bankruptcies, there were other factors that contributed and they still exist today.
So, to talk about it, I’m joined by my business partner and Hoyes Michalos co-founder, Ted Michalos. So Ted, other than the credit crisis, what else happened in 2009 to spike the number of personal bankruptcies?
Ted Michalos: Well, beyond our belief in 2009 the government decided it was time to make major revisions to the Bankruptcy and Insolvency Act. So, in the middle of the worst financial crisis we’ve seen in a generation, the government made it more expensive, more complicated and longer for someone to find relief from their debts.
Doug Hoyes: And as a result there was a big spike that year. But those changes still exist today; nothing has changed in terms of the law. So, for example a bankruptcy back in 2005 compared to today, what’s the big difference?
Ted Michalos: Well, in 2005 the rules were, I’m going to say, a little bit looser. So, depending on how much money you’re making your bankruptcy might have lasted nine months. That was pretty much the norm. And in some cases trustees would extend them by another 12 to make them 21.
Well, in 2009 the government imposed rules that basically said if you’re making more money than they think is appropriate or sufficient, then you’re bankruptcy is going to be 21 months long. So, all of a sudden people that were getting out of bankruptcy inside of a year, were now taking two years to get themselves clear.
Doug Hoyes: So, right prior to those changes that happened in September of 2009, a lot of people went bankrupt who didn’t want to be caught in the new rules. And then right after the changes came into effect a lot of people filed consumer proposals so they could avoid the bankruptcy and that caused a bit of a spike. So, now after 2009 there was a big drop in bankruptcies.
Now it takes the government two or three months to release numbers so it will probably be February or March before we know the 2014 numbers. But we know that in both 2012 and in 2013 there were only about 118,000 consumer insolvencies, which is obviously a huge drop, 33,000 people or a 22% drop from the peak in 2009. So, what happened? What’s happened over these last few years to cause such a huge drop?
Ted Michalos: Well, so we touched on it. Part of it was there was this enormous spike in 2009. And the other was that the revisions that they made to the law in 2009 made consumer proposals much more attractive to many more people.
If you think back historically it used to be that they would, and they being the public, would file three bankruptcies for every proposal. That was pretty much the norm across the country. In Ontario I think it was two bankruptcies for every one. This is talking back to 2008, 2009. The ratio now is pretty much even, a one to one proposal to bankruptcy swing. And I think in Ontario we’ve actually got more proposals than bankruptcies being filed now. So, part of the reason that bankruptcies are down is because more people are taking advantage of the consumer proposal solution, which by the way is an excellent solution.
Doug Hoyes: Oh, I totally agree. Now the total overall numbers are also down and so let’s talk about the economy then. What are the big changes we’ve seen in the economy that have reduced the requirement for people to have to file for insolvency?
Ted Michalos: Well, the thing that everybody is riding on right now is the fact that money is free. It isn’t literally free but interest rates, well I think my mortgage is at 2%. And most of the people that we talk to, that come into our offices, have mortgages somewhere between two and three and a half. At that rate you can carry an awful lot of mortgage.
So, people are able to either refinance their homes to tap into money at lower rates or just the interest rates they’re paying on things like lines of credit and even personal loans are so much lower than they used to be. You can carry a lot more debt because the payments aren’t as large.
Now, the thing that’s scaring the day lights out of us is sooner or later those interest rates have got to go up. You cannot have free money forever. Historically the bottom rate for most things like mortgage is somewhere 4 and a half, five percent. I mean that’s the way it was forever. My grandfather tells me that. And we just can’t sustain 2 and a half percent for much longer.
Doug Hoyes: So, it aint going to last.
Ted Michalos: It can’t. There is just no way these low interest rates can last for much longer than - well we’ll talk about that in the second part of the segment when we’re predicting 2015.
Doug Hoyes: So, and it’s not just mortgages of course. Credit card interest rates are still just as high as they’ve ever been. But car loans for example are also much cheaper. What do you see happening in that front?
Ted Michalos: Yeah, that’s another area where things have just gotten a little crazy. It used to be the longest period you could get for a car loan was 60 months, five years. And then they went to seven years. Recently I saw eight years and I know that people are running ads for ten years. Ten years for a car loan is insane. The car is going to last, what three or four years and then you’ve still got this debt.
Doug Hoyes: So, people are deceived at the moment by what appears to be free money but really isn’t.
Ted Michalos: Yep.
Doug Hoyes: And as a result they’re getting themselves into huge trouble. And isn’t this really what we saw back in 2008 with what they used to call the subprime crisis?
So, back in the U.S you were able to get houses with no money down. They weren’t really doing very detailed credit checks. A lot of people ended up financing houses that they couldn’t afford. That whole bubble burst. Is it possible that the same thing could happen with car loans?
Ted Michalos: Well, it’s a different kind of bubble. So, the bubble that burst in 2008 was the world suddenly realized that all of these things that they have listed as security and collateral for the bank’s money had no real value. And so, suddenly everyone just kind of puckered up and they tightened up the money supply so that, literally Labour Day, 2008 you could have got a loan in August, you couldn’t get the loan in September. They just wouldn’t give you the money. It’s not that the money disappeared; they just said we don’t trust anybody. We’re not giving it out.
The car loan issue is a little more nefarious. So, I’m a large corporation, I can afford all this free money, this 1% bank loan. So, I can allow you to buy this car. I’m only paying 1% of the money and it doesn’t make a big difference. Three years from now when the interest rates have gone up, those deals won’t be in place anymore. You’ll still be locked into that deal and the car company doesn’t care. So, if you can’t carry the loan, well maybe you’ll trade it in and get a new one and now your new loan will be a higher interest rate anyway.
Doug Hoyes: But if you’re getting a loan that’s going to last seven to ten years and the car is going to last from five to six, then you’ve got a real problem. It’s the back end where we’re going to see the issues.
Ted Michalos: That’s right. What used to happen with a five year loan, you have to be three years into it before the amount you owed on the loan was lower than the value of the car. So, with a seven year loan, you got to be four and a half or five years into the loan. With a ten year loan you got to be six years, seven years into the loan before the actual amount you owe is lower than the value of the car. It’s just insane.
Doug Hoyes: So, there are some problems to come. Now people seem to be getting their credit card debts under control. When we look at the numbers, the credit card debt isn’t increasing and that’s probably because it’s at 19% interest. People are smart; they say, hey wait a minute I now have access to things like unsecured lines of credit that have lower interest rates. So, overall debt continues to increase, credit card debts aren’t increasing but lines of credit are. Do you see that as a problem going forward?
Ted Michalos: Yeah, so when you said that people are getting smart, they’re only getting half smart.
So, we’ve been preaching for years the best way to deal with credit card debt is to get yourself an unsecured line of credit. It’s going to be at 8 to 10% interest, your payments are going to go towards the principle instead of interest. You’re going to save some money.
The second half of that advice always was cut up the credit cards. And so if you don’t, all you’re doing is doubling down. You had $20,000 in credit card debt; you’ve got a line of credit to pay it off. You kept the credit cards and guess what? Most people run up to $20,000 again.
So, now what started out as a great strategy to reduce your debt and reduce your interest, turned into, you’ve doubled your debt. And that’s what we’ve seen in the statistics. I mean I think Canadians are now carrying, what is it 162% of their income? Again, that’s just a crazy level.
Doug Hoyes: Yeah and it’s a big number. So, you’re not opposed to lines of credit. You’re not opposed to paying lower interest rather than higher, but you have to be reducing your total debt as a result of that.
Ted Michalos: That’s exactly right.
Doug Hoyes: And if all you’re doing is paying off your credit cards with your line of credit and then running up the credit cards again or having a bigger line of credit, you’ve kind of missed the point. You’re not taking advantage of these low interest rates. And that’s really what you need to be doing now.
Ted Michalos: That’s right. All you’re doing is doubling the burden which is what Canadians have been doing for the last five years and it’s going to come back to bite them in the butt.
Doug Hoyes: Well, let’s talk about what’s going to come back. Let’s talk about predictions. We’re going to take a quick break and then in segment number two it’s going to be prediction time. What’s going to happen in 2015 and beyond? We’ll be right back with that.
You’re listening to Debt Free in 30.
We’re back on Debt Free in 30. My name is Doug Hoyes and I’m joined today by Ted Michalos and we’re talking about 2015. This is our first show of the year and we’re talking predictions. What’s going to happen in 2015 and beyond?
So, it’s prediction time now. As we discussed in the first segment the year 2012, 2013 Canada had almost an identical number of personal insolvencies, about 118,000 each year, down considerably from the peak back in 2009, which we talked about in the first segment. The final numbers for 2014 aren’t in yet. It takes the government two or three months to assemble them. But what are you expecting Ted, for 2014 when the numbers finally come out? Any big changes from 2012 and 2013?
Ted Michalos: Yeah, now the year is over I think we’re looking at almost identical numbers again; 117,000, 118,000 people across the country will have had to file a bankruptcy or a proposal.
Doug Hoyes: So, that means it’s likely that 2014 will be the fifth straight year that personal insolvencies in Canada have declined, albeit by very small numbers, a few hundred each year. They may go up slightly. We won’t know till the final numbers come in. But, that’s pretty much unprecedented. As far back as the stats go, it’s never happened before that we had that long of a drop.
What do you think is going to happen then going forward? And I guess really to answer the question for 2015 it all depends on what the general economy’s going to do. So, let’s pick off the different items in the economy. What do you think’s going to happen with interest rates, big changes, no big changes? What do you see happening there?
Ted Michalos: Yeah, that’s the most important factor I think that’s going to affect all of these other things and it’s the thing that has the biggest impact on the economy. I’m thinking back now, the last predictions that the U.S government made, their congressional budget office - and we only pay attention to those because the U.S economy is such a big driver of the world economy - they’re talking about interest rate increases by the fall of 2015, spring of 2016 at the latest.
So, that means some time after Labour Day we should expect that interest rates should start creeping up. I don’t think anybody is talking about a dramatic or quick increase. But it’ll start going up a quarter point or half a point every time that the feds sets their rate. And that has a ripple effect throughout the economy. It’s kind of like watching gas prices. Whenever gas prices go down, they go down slowly, when they go up, they go up quickly. So, if the oil company knows they can jack up prices tomorrow, because you heard on the news that oil’s gone up, well the same things going to happen with interest rates on loans and mortgages and everywhere else. As soon as they get nervous they’ll start climbing.
Doug Hoyes: And of course predictions are not worth the paper they’re written on. I’m sure if we looked at the U.S budget office’s predictions going back years, they were always wrong just like the Canadian government’s private economist, everything’s always wrong. Our best guess is we’re not going to see any substantial changes in the short term, longer term who knows. And we’ll talk about what that all means shortly. But what about some other things, what about the unemployment rate? It’s pretty low at the moment. Do you expect any changes in that in the near future?
Ted Michalos: Well again, unfortunately I think 2015 is going to look like 2014. So, they’ll be slight increases in the number of employed but it won’t be enough to make a huge difference. But right now we’re at pretty decent levels. That may have an impact on insolvencies because the longer people are back at work than the more likely the collectors are going to start saying well we can go after some of these debts that they might have defaulted on two or three years ago when they weren’t working. But that’s a different part of this discussion.
Doug Hoyes: So, your best guess then is 2015 is going to look at lot like 2014. No major changes early in the year on interest rates, inflation, unemployment, that sort of thing.
Ted Michalos: That’s exactly right.
Doug Hoyes: Which means that the bankruptcy rate will be in about the same range as it’s been in the last two or three years, no big changes there.
Ted Michalos: That’s exactly what I’m expecting. 2015 is going to look like 2014, which looked like 2013.
Doug Hoyes: So, what does that mean then for the average person who’s listening to us today?
And let’s take a look at some specifics then. So, we’ve seen in the past few years, and we kind of touched on it in the first segment that there has been this trend towards variable rate callable debt. So, 20, 30 years ago you got a mortgage, it had the same rate for 5 years, 10, years, 15 years, you locked in, now lots of people have variable rate mortgages.
We now have lines of credit that represent a significant amount of our debt. And they are both callable and variable. So, callable meaning what you just said, the bank can change their mind at any point and say hey I’m calling in the loan, I want it tomorrow or I’m jacking up your interest rate tomorrow. Variable rate means it can change one way or the other. If nothing’s going to change in the next six months, do we really have to worry about that? Is it fine to continue having large car loans, variable rate lines of credit? Or is that something we should be concerned about?
Ted Michalos: So, the advice people should hang their hat on is, variable rate right now is a good thing. You’re probably saving money. So, if you’ve been in a variable rate mortgage for the last couple of years, you’ve definitely saved money. What you got to watch is when’s the point that you need to lock it down or lock it in?
So, if we’re saying there won’t be any interest rate increases until after Labour Day, probably the first six months of this year, you’re okay to stay with what you’re doing. But you should be paying attention to the markets. A half a point increase in your mortgage will be an extra $50 a month for every $100,000 that you owe.
So, the average person that we talk to has about a $300,000 mortgage on their $350,000 home, that half a point increase then, just cost them $150 a month. And there’s no new money coming in. That’s money you’ve got to find and take from someplace else.
So, at some point you’ve got to say, wait a minute it’s time to switch from variable to locked in so I have some security, so I have some surety that this interest rate isn’t going to get crazy.
Doug Hoyes: And you’re talking about a half a point increase, what if they go up 2 percentage points.
Ted Michalos: Yeah, so two percentage points, people are going to lose their houses.
Doug Hoyes: Now you’re talking $600 on that $300,000 mortgage. And I guess the question everyone has to be asking themselves right now is, okay so if interest rates stay the same I guess nothing changes. But if they tick up even just a little bit, can I afford to be paying an extra $200, $300, $400, $500, $600 a month on my mortgage? If I can’t, if that would kill me, then what are the practical things that I should be thinking about doing right now before that even happens?
Ted Michalos: So, the defensive thing to do is figure out how much of a mortgage payment can you afford. So, let’s talk about mortgages first cause it’s such a big number for so many people. And once you determine what that number is, and you need to look at what you’re actually paying now and how sensitive is what you’re paying now to an interest rate increase?
So, let’s say your mortgage payment is $750 bi-weekly and you think you can afford to go to $800. Well, that means if the mortgage rate goes up more than half a point, you’ve now exceeded the amount of money you had left in your budget.
So, you need to try to decide at what point do I need to lock this in? It might cost you a little extra if you guess wrong. So, you switch from a variable rate mortgage to a locked in rate in June and the rates actually stay down till December. So, you’ve paid a little extra for six months. But you’ve made sure that when the rates do go up, and they are going to go up folks, there’s no way to get around that, that you don’t suddenly get hit in the side of the head.
Doug Hoyes: So, it’s thinking in advance about – really what this comes down to is, can I sleep at night? That’s really what we’re talking about.
Ted Michalos: That’s exactly what we’re talking about. Have you got – what’s your comfort level? Are you gambler? Gambling with your house with your loan payments, with your lines of credit is just so dangerous for so many people. I just can never recommend it.
Doug Hoyes: And so it’s been fantastic the last few years with variable rates cause the rates keeping going down. So, I keep winning and winning and winning. But when they tick up I’ve got a problem. So, maybe I’m paying $1,200 a month now on my variable rate mortgage and if I locked in it would cost me $1,300. But if that extra hundred dollars is easily affordable to me and I can lock it in for the next five years then I guess I can sleep tight for the next five years and I don’t have to worry about it.
Ted Michalos: That’s exactly right. So, you’re paying extra this year but okay in 2016 the interest rates go up and now your variable rate mortgage is $1,400 a month. Well, you locked it in last year at $1,300 so you’re a winner. That’s what we’re talking about.
Doug Hoyes: And I guess the even bigger point here is the way to protect yourself from whatever can possibly happen in the economy, whether it’s you lose your job, interest rates go up or whatever, is to be carrying as little debt as possible. If interest rates double but I have no debt, I guess I don’t have to worry too much. So, if we -
Ted Michalos: In fact if interest rates double and you don’t have debt, you probably have savings and so now you’re making money.
Doug Hoyes: So, you’re much better off to be reducing your debt then.
So, okay and in the last couple of minutes that we got here in this segment, people are listening to us, they’ve got a lot of debt, what should be going through their mind right off the bat?
Ted Michalos: So, dealing with debt is usually a question of priorities. You’ve got to make some lifestyle choices. Is it more important to continue doing what you’ve been doing for the last couple of years or is it time to listen to these guys on the radio and start pounding away at the debt? If you agree with us that debt’s a bad thing, something you shouldn’t carry, then take a look at what it is you owe and who you owe it to and start dealing with the highest interest rate debt first, pound away at this stuff. Get your debt reduced while money is free. You make an extra payment now, it’s not going to interest, you’re paying down principle.
When interest rates are 10, 11, 12% on a line of credit and you make an extra payment that has an impact. But right now when it’s 5 or 6%, it’s principle. You’re saving not only money today but you’re saving money tomorrow and they day after that and the day after that because you’ve reduced the total amount that you owe.
Doug Hoyes: So, you’re being given a gift right now. Interest rates are low, take advantage of it. Don’t use low interest rates as an excuse to borrow more. Use them as an excuse to get the debt paid down so that when interest rates go up, it’s not an issue.
So, final point then, somebody who is listening to us today who has a massive amount of debt and there is no way they can pay it off, does it still make sense to try and deal with it today?
Ted Michalos: Debt problems don’t go away. If you’re already feeling stressed because you’re carrying more debt at low interest rates, then you really should reach out and talk to a professional. And I guess that makes this a bit of a commercial for what we do, but at the end of the day it is about can you sleep? Can you look after yourself? Can you look after your family? And if you’re carrying more debt than you can deal with, then you need to talk to somebody, a professional that can help you sort it out.
Doug Hoyes: Totally agree, thanks for having you here with me today Ted.
We’re going to take a quick break and I’m going to wrap it up and give you some practical advice on how to deal with that specific debt if you’re carrying more than you’ve got, so that you’re prepared for 2015. We’ll be right back on Debt Free in 30.
Welcome back. It’s time for the 30 second recap of what we discussed today. My guest today was Ted Michalos and he gave his predictions for 2015. Our best guess is that interest rates will remain low, the economy will stay about the same, and the bankruptcy rate will stay the same or decrease slightly. However there is always the risk of some external event that throws the economy back into a recession. That’s the 30 recap of what we discussed today.
So, what’s my advice for 2015? My advice for 2015 is the same as it was for all previous years. Become debt free.
It’s true that interest rates are low, the unemployment rate is stable, inflation is low and the economy looks to be in decent shape. My advice is to not worry about the general economy but instead to devote all of your mental energy to your situation. You can’t control whether or not interest rates go up or down. You can’t control whether or not your employer closes up shop. But you can control how much debt you have.
So, that’s where you should work to improve your own personal situation. If you don’t have debt, great, increase your savings because that is never a bad idea. If you have a lot of debt work to eliminate it and become debt free. What if you have a huge debt mess?
Stay tuned because next week we’ve got an entire show on cleaning up your debt mess. I’ll be joined by Gail Vaz-oxlade and Ted Michalos and next week we’ll give you lots of practical tips for cleaning up a debt mess.
That’s our show for today. Full show notes are available on our website and I’d love to hear your comments which you can leave right on our website at hoyes.com. Thanks for listening. I’m Doug Hoyes. That was Debt Free in 30.