When you make a consumer proposal, your trustee will want to look at your budget to determine how much you can afford to offer your creditors. This budget will also be included in the statement of affairs package sent to your creditors to help them decide whether to accept your offer or ask for more money. Today I’ll explain how to make a consumer proposal budget and how filing a proposal can help bring your budget back into balance.
Cashflow before you file your consumer proposal
When you are in financial difficulty, it’s hard to imagine you can ever have enough money. Today your cash flow may not cover all your household and monthly expenses, including rent or mortgage payments, car payments, food, clothing, utility costs, insurance and all of the other expenses that you can’t avoid. Often this is because debt payments are taking up too much of your current monthly income.
Some people try to solve a negative budget problem by making only the minimum payments on credit card bills, but this won’t help you get out of debt.
You need a plan to deal with debts that you can reduce your stress and get your fresh start. But that plan has to balance your budget and a consumer proposal can help make this happen.
Why your budget is important
When considering a consumer proposal, the most important question is, can I afford the monthly payments?
To be sure that the cost of your consumer proposal fits within your budget, your trustee will look at your monthly expenses and determine whether you can afford to complete the process.
A consumer proposal will offer you protection from your creditors, stop interest charges, but it must offer your creditors more than they would receive in a bankruptcy. However, you must be able to afford the payments. That’s where your budget comes in.
Your trustee will review your budget to see what expenses will disappear (like credit card payments) and where you might cut back to help you better make ends meet.
If you don’t know if you can afford your monthly proposal payments it could mean added, unnecessary stress. Skipping proposal payments is dangerous because legally, you are only permitted to miss two monthly payments over the course of the proposal. If a third payment is missed, the proposal is automatically annulled. Once annulled, you lose the creditor protection that your proposal offered, and your debts could go back into collections. This is why it’s so important to be prepared and be honest with yourself and your trustee about where your money is going. A budget helps you make sure your proposal is affordable at the start and makes sure that you will be successful and receive your Certificate of Completion, so your debts are eliminated for good.
How to prepare a consumer proposal budget
At Hoyes Michalos we will send you a link to provide some income and expense information to your trustee to help prepare your consumer proposal. However, here are some line items you will want to include in your budget:
Income items to include:
Employment income
Pension income
Child support or alimony
Government benefits (child tax, welfare, disability)
Other income
If you are self-employed or operate a business, you need only include your net income, after deducting relevant business expenses.
A consumer proposal considers a household budget so your trustee will ask for this information for both you and your spouse.
Expense items to include:
Household expenses
Rent or mortgage payment
Property taxes
House / content insurance
Utilities – hydro, gas, water
Telephone / cell phone
Cable / internet
Furniture
Transportation
Gas
Car loan / lease
Public transit
Car repairs / maintenance
Vehicle insurance
Plate renewals
Living Costs
Food & groceries
Restaurants
Entertainment
Laundry / dry cleaning
Grooming / toiletries
Clothing
Smoking
Alcohol
Gifts and donations
Health
Life insurance
Disability insurance
Prescriptions
Dental
Other
Child care / babysitting
Banking fees
Gifts / allowances
Memberships
Pet care
If you pay for expenses annually (for example memberships, insurance or Christmas gifts) do your best to estimate how much you will need to set aside every month to cover these costs.
Eliminating current debt repayment
You will notice we did not include monthly debt payments in your consumer proposal budget other than those you wish to maintain which are typically secured loans like your mortgage or vehicle financing. Assuming you wish to keep these assets you will need to keep up with these payments which is why they are included in your budget.
When you make a consumer proposal, you have no unsecured debt payments. As I mentioned earlier, today your minimum payments on credit cards, high-interest installment loans and payday loan repayments are likely why your budget is negative.
When making a proposal to creditors, your trustee will look at your income minus your expenses before debt repayment. This number is hopefully positive. If it is not, your trustee can talk about ways to reduce your expenses or, if you feel it makes sense, return an expensive car to reduce your outgoing costs enough to bring your budget into balance.
Your trustee will want a list of who you owe money to. Based on your total debts and your creditors your trustee will know what minimum percentage to offer. This can be balanced out with your budget to see how much you can afford to repay.
Why a consumer proposal is better for your budget than bankruptcy
We talked earlier about how much your creditors will expect to receive and that they will want more under a debt proposal than they would if you were to file for personal bankruptcy. Since your creditors will be paid more you might wonder how this is good for your budget.
How long a person may be bankrupt is affected by how much income they make. Government rules say the more you make, the more you must pay in a bankruptcy and the longer you must make those payments. Someone who files bankruptcy the first time with surplus income payments is mandated to be in bankruptcy for 21 months. This time period cannot be lengthened or shortened. This can make monthly bankruptcy payments high relative to your available cash flow.
Consumer proposals can have a repayment term of up to five years. Spreading out your payments by up to the allowable 60 months can help you lower your monthly payments. This can mean the difference between a balanced budget and continuing to struggle to pay your everyday living costs.
Budgeting after your consumer proposal is filed
After your consumer proposal is filed, you will be required to attend two credit counselling sessions. One of these sessions will be devoted to how to budget and live within your means. While the primary reason to file a consumer proposal is to eliminate your debt, the second goal is to ensure that you don’t rely on credit to cover everyday living expenses moving forward. A consumer proposal can give you a fresh start and now you can work towards building some savings for the future.
Contact us to see if a proposal can help balance your budget
A consumer proposal can eliminate your debt, allow you to keep your assets and help you get back on track financially.
If you are dealing with debt, contact us for a free initial Debt Free in 30 debt assessment during which we will review your budget, help you determine how much you can afford to pay and what offer you might propose to your creditors.
The world is an interesting place and if you can imagine something, then someone, somewhere can find a way to sell it to you; even if the information is available for free. Really.
Case in point – bankruptcy advice.
A not so little industry has been created in the last decade made up of people who, for a fee, will explain to you everything they know about bankruptcy law. They call themselves Debt Consultants and Credit Counsellors but they are not licensed trustees in bankruptcy (now known as Licensed Insolvency Trustees). If the fees were modest and the advice was accurate, then I wouldn’t mind. Unfortunately, the fees are not modest and the advice is frequently wrong.
In the interest of full disclosure, I need to tell you that I am a chartered professional accountant and a licensed insolvency trustee so I have a definite bias about who you should talk to for bankruptcy advice. Not surprisingly, I think the advice should come from the right bankruptcy trustee and here’s why.
Only Trustees Can Administer a Bankruptcy or Consumer Proposal
Trustees are licensed by the federal government to administer proposals to creditors and bankruptcies in Canada. No other professional, other than a Licensed Insolvency Trustee, may do this.
Accountants can’t. Lawyers can’t. Debt consultants most certainly can’t.
Because lawyers and accountants cannot provide these services very few of them have detailed knowledge about proposal and bankruptcy law. They may have a general knowledge of the concepts, but lack specific details for how the law may affect you, if you decide to file. Every individual situation is unique, and only someone with qualifications and experience can provide advice tailored to you.
Most professionals recognize they have limited knowledge in these areas – their advice will be to call a trustee. Unfortunately, debt consultants and many for-profit credit counsellors take the opposite approach. Since they have some knowledge of debt management options, many feel this gives them license to give out bankruptcy advice.
When you meet with them, these debt consultants will likely know more than you do and therefore they may come across as knowledgeable and helpful. In reality, debt consultants prey upon common fears: your wages will be garnisheed, your house will be taken away from you, your family and friends will find out about your money problems, and often their final pitch — trustees are not on your side. The advice these people provide is designed to convince you that your only hope is to follow the plan they lay out for you, including paying them a fee before they will refer you to their “guy” to solve your financial problems. Their “guy” is often called an officer of the court or a government expert. The truth is their “guy” will be a licensed trustee since, as I mentioned earlier, only a trustee can help you file a consumer proposal or bankruptcy.
Watch the video below for more information about for-profit financial consultants:
Interviewer: I’m going to fire the next one at Ted because it will infuriate him.
Doug: Here we go folks.
Interviewer: We’ve all heard advertising from debt consultants saying that they can consolidate, settle, negotiate your debts, now can they really help or is that a myth?
Ted: Well yeah, the normal line is ‘we can reduce your debt by 70%, we don’t represent your creditors, we represent you, we can help you work out a plan’. I’m not sure where to start with these guys, they just drive me crazy. 1 out of every 4 people in the GTA now are paying a fee to one of these debt consultants, 1 out of every 4. And so, what they do, is they run these ads, preying upon people that are already in financial difficulty. You’re already having trouble paying your bills, and they say ‘well sit down with us and we’ll talk about your situation’ and what they’re doing is they’re crafting their sales pitch. And the sales pitch is, ‘you know what you should do? You should file a consumer proposal, to file a consumer proposal you need to go see this guy’. And now they’ll tell you that guy’s name after you’ve paid him the fee. And earlier I said it was sometimes hundreds, sometimes thousands, I’m not kidding, literally. For the average individual the fee is somewhere around fifteen hundred dollars. And so, they’ll meet with you 2 or 3 times, usually takes anywhere between 4-6 weeks because most people don’t have $1500, and as soon as your last cheque is cleared, ‘now you need to go see this guy over here and he’ll file a proposal for you’. It just drives me nuts.
Interviewer: Ok so we know where Ted stands on this, Doug what are your thoughts, is Ted right?
Doug: Yeah, I’m afraid Ted’s right on this one, I would have to agree with him on this one. I remember meeting with a lady a number of months ago who had been paying them $750 a month, for 9 months by the time she came to see us and they still hadn’t called her creditors or anything. In fact, she had never actually met with them in person. It was all done over the phone; I don’t think they were even in the province.
Ted: Is this one of those Internet – sorry these guys – you’re doing this on purpose now okay –
Doug: But it’s true, you don’t even – I mean at Hoyes Michalos you actually get to come in and meet with a live person, you know, more than once, whereas these guys are all you know potentially over the internet on the phone whatever. I’ve got 3 big problems. The 1st one is they aren’t regulated by anyone. So, Ted and I have a licence from the federal government to do consumer proposals. I went to university, when I finished university, I spent another 3 years to become a chartered accountant and after that I spent another 5 years to take all the courses to become a licensed as a trustee and bankruptcy. Anybody can become a debt consultant by hanging out a shingle. Now, I’m not saying that they’re all bad, they’re all evil, what I am saying is before you deal with somebody ask ‘who are you regulated by? Who are you licensed by?’ There are not for profit counsellors here in town who are great. They are a member of the Ontario Association of Credit Counsellors who monitor what they do, so I’ve got no problems at all recommending people like Mosaic Family Counselling here in Kitchener, Guelph Family Counselling in Guelph, Brantford Family Counselling in Brantford, they’re all great people. But when you talk with one of these for-profit guys, okay who exactly regulates you? A lot of them, amazingly enough, are regulated by the Collection Agencies Act. They are actually licensed as collection agents, because that’s the only licensing body there is. So, do I really want to deal with a guy who really is a collection agent? Well probably not, so that’s problem number 1. Ted already mentioned problem number 2, which is these huge upfront fees. And I agree with Ted, I think $1500 is kind of the normal number that you see, and it can be a lot higher than that. 3rd big problem is there is no legal protection from anything that they do. When you file a consumer proposal with us, you instantly get legal protection, nobody can sue you, garnishee your wages until a proposal is decided upon. With these guys, Ted’s right, they tell you ‘hey you know, don’t pay your creditors for a while, we’ll work something out’, in the meantime of course you run the risk of them taking you to court, suing you and garnishing your wages, so I agree with Ted it’s a problem.
Ted: the part that will drive people crazy, at the end of the day, you’re going to have to deal with a Trustee to file a consumer proposal. That’s what we do, that’s what we’re licensed to do, lawyers can’t do it for you, non-profit agencies, none of these other guys can. So, does it make a lot of sense to pay somebody else a fee before you come and see me? No.
Doug: there will be no upfront fees when you come to see us, it’s as simple as that. Now it’s not just because Ted and I are good guys, I mean we realize you don’t have any money, you’re in debt that’s why you’re coming to see us. But we are regulated by the federal government, and one of the terms of our license is we’re not allowed to charge any upfront fees. So, that’s why there won’t be any. So, if you’re talking to someone over the phone from British Columbia, who you’ve never met with and they want $1500, you’ve really got to ask yourself some questions. So do your due diligence, go to their website, go to the Better Business Bureau see what’s there. You know, find out who you’re dealing with before you start parting with your hard earned money.
What you are never told is that the licensed trustee would have met with you for free and explained your options in greater detail. Licensed Insolvency Trustees are required by law to review all of your debt relief options, not just sell you a proposal or bankruptcy. I know in our own practice, the vast majority of people that contact us do not need to file either a proposal or bankruptcy. In most cases, they need some frank, but friendly advice on how to re-organize their finances to get out of financial trouble.
I am not telling you that the only place you should seek financial advice is from a licensed trustee. What I am saying is that if you think you need specific advice regarding filing bankruptcy or a consumer proposal, you should speak directly to a licensed insolvency trustee. Only a licensed trustee can provide these services, so paying a fee to anyone else before you speak to a trustee is simply a waste of time and money.
If you are wondering who to contact, I encourage you to read more about Hoyes Michalos and our 11-point promise to our clients. Then, when you are ready, book a free consultation where we give you options to be debt free.
On today’s show I talk with Vikram Barhat, a financial writer based in Toronto whose work has appeared on the BBC, Morningstar Canada and The Globe and Mail. He writes about investing, personal finance, wealth management and real estate. Vikram answers the question, should we pay down our debt or invest in an RRSP? On our Let’s Get Started Segment of the show, Ted Michalos, co-founder of Hoyes, Michalos & Associates Inc. joins me and tells us why it’s important to pay off consumer debt first.
When considering where your hard earned money should go, it’s important to understand what a Registered Retirement Savings Plan (RRSP) is, how it works and how best to use it. Vikram points out that there are common misconceptions about what an RRSP is and explains that it is a tax deferment program and not a tax deduction plan. He explains that,
the government allows you to contribute up to 18 percent of your earned income from the previous year to an RRSP. You are also allowed to deduct that amount from your income. That means, depending on your income, you may get a tax refund after you’ve filed your tax return…
However, the tax burden is deferred in that you pay tax on the amounts withdrawn from an RRSP when it is actually withdrawn. You have a benefit in the short-term by reducing your taxes and using the excess funds toward other financial goals. The long-term benefit for most people is that they will have a lower tax rate when the funds are withdrawn in retirement years.
Debt or RRSP
I ask Vikram about the level of debt that Canadians are carrying today, and his answer is that debt levels are alarming. He explains that,
according to the latest Statistics Canada report, Canadian household debt, which includes mortgages, loans and credit cards to disposable income was a record 163.3 percent in the last quarter of 2014.
This means that if I make $10,000 a year, my debt is around $16,000 and that the average Canadian’s disposable income is not increasing as much as their debt load. Vikram cautions that this income to debt ratio will only get worse before it gets better and that today, Canadian’s debt load is at a historical high.
So how do we decide where our money should go? Is it better to save for the future or to pay down debt that we already have?
Paying off debt (such as a mortgage) faster, reduces the amount of interest you will pay.
The current low interest rate environment is a guaranteed return versus the uncertain rate of return from an RRSP.
There are many psychological benefits to paying down debt, including reduced financial stress in retirement.
When it comes to deciding whether to invest or pay down debt, there is no “one size fits all” answer. Factors such as age, salary, job security and the amount of debt you’re carrying all affect the decision making process. For example, Vikram points out that younger individuals may be wiser to pay down their debts rather than invest in an RRSP. That way, they’ll save on interest and still have plenty of time to invest for retirement in the future (especially if they do not have job security).
Ted Michalos, co-founder of Hoyes, Michalos & Associates Inc. Ted emphasizes the importance of paying down consumer debt rather than investing in an RRSP. He explains that,
…most Canadians are not contributing the maximum amount…so what happens, you don’t have a large amount in your RRSP when you retire anyway, and so when you convert that RRSP into an RRIF and you get the monthly payment, what it does is it reduces the money you’re receiving from the government pensions.
When there isn’t enough money in an RRSP to make a significant difference, it decreases the amount that you’re entitled to from the government. Ted points out that instead of getting an OAS cheque, these individuals get less of it or nothing at all.
Ted’s answer is that if you run the numbers and find that you won’t be able to contribute enough to your RRSP by retirement, it’s time to pay down consumer debt starting with the highest interest debts first. And if you have so much debt that it is preventing you from saving for your retirement, consider talking with Licensed Insolvency Trustee about debt relief options.
Full transcript for today’s podcast available below.
Also broadcast as Episode 101 for the Best of Series
So, let’s say you just got an unexpected thousand dollar bonus at work. What should you do with the money? Is it better to pay off your debt or invest in an RRSP? How do you make that decision? Is it as simple as looking at interest rates and your tax rates, or is there more to it than that? To find out, I’ve invited an expert on the show to discuss it, so let’s get started. Who are you and what do you do?
Vikram Barhat: Hi, My name is Vikram Barhat, and I’m a Toronto-based financial freelance financial writer. I write about investing, personal finance, wealth management, real estate and other business and finance issues. I worked in various editorial capacities in three different parts of the world, and I currently write for the BBC, Morningstar Canada, The Globe and Mail, and a few other publications across Canada.
Doug Hoyes: Great, well, thanks for being with me today, Vikram. So this show is called Debt Free in 30, so to start, give us an idea of how much debt we’re talking about. What level of debt are Canadians carrying today?
Vikram Barhat: The word that comes to mind, straight off the bat is alarming.
Doug Hoyes: Yeah [laughs].
Vikram Barhat: [Laughs]. According to the latest Statistics Canada report, Canadian household debt, which includes mortgages, loans and credit cards, to disposable income was a record 163.3 percent in the last quarter of 2014. Now, to put this in perspective, it’s the same as the US in 2007 just before the financial crisis. Thanks to the massive deleveraging though, it stands at a much lower level in the States, perhaps 140 or lower, which is pretty much the same direction that Canadians seem to be headed. But all indications show that the debt to income ratio in Canada will likely get worse before it gets better. And one of the key reasons that’s come up in recent discussions around the subject is the fact that Canadians’ disposable income isn’t going at the same pace as the debt load.
Doug Hoyes: And obviously that’s a problem going forward for us, so let’s just emphasize what you just said there. So current debt loads are in the 160/165 percent of disposable income range. So that means if I make $10,000 a year my debt is around $16,000.
Vikram Barhat: That’s correct.
Doug Hoyes: That’s what you’re saying.
Vikram Barhat: That’s correct.
Doug Hoyes: And like you said, that includes all forms of debt; that includes mortgages and everything. And that may not sound like a big number, because people go “Oh, well, okay, so if I go out and by a house” – and in Toronto, what’s the average house, now, a million bucks? So –
Vikram Barhat: It’s such a [unintelligible 00:03:17].
Doug Hoyes: Yeah, it’s ridiculous. So, okay, I had to go get a mortgage of 5- or 600,000. Well, if I make $100,000 a year that means I’m carrying 500 percent of my debt. My debt is 500 percent, five times my disposable income. That doesn’t seem like such a big number. But I guess the point you’re making is historically that is, number one, about as high as it’s ever been in Canada, and number two, as high as it was just before the US had their credit crisis in 2008. That’s what you’re saying.
Vikram Barhat: That’s right, that’s correct. That’s sort of a good benchmark to have just to get a sense of how alarming the situation is in Canada in this point in time.
Doug Hoyes: So it’s something we should be concerned about even if the number maybe doesn’t seem that big. It’s as big as it’s ever been, and historically it’s caused serious problems. Okay, so we’ve got a lot of debt, I understand that. So as a Canadian, then, I’ve got two kind of competing objectives. I know that pensions keep getting eroded and may not be there by the time I want to retire so I need to save for my retirement, but, as you just said, Canadians are carrying a huge amount of debt and a lot of that debt is mortgage debt. So how do I decide if I use my extra funds, this thousand dollar bonus I just got, how do I decide if I use that to pay off debt or to save for retirement? What’s your thought process on that?
Vikram Barhat: Well, first of all, congratulations if you have extra funds.
Doug Hoyes: Yeah [laughs].
Vikram Barhat: [Laughs]. But seriously, though, having to choose between saving for retirement and paying down mortgage debt does seem like fighting a losing battle, because the vast majority of the Canadians are only able to afford one or the other. The general consensus amongst financial experts seems to be in favour of paying down debt given the levels of debt that we are facing right now. And there are three key arguments to support that view.
Number one, the faster you pay off your mortgage, the less total mortgage interest you have to pay. Also, you reduce the amount of your mortgage that you may need to be renewed at a higher rate down the road. Number two is in the current low interest rate environment paying down a mortgage is almost as good as a guaranteed return, while investing in RRSPs is not. And number three is that, more importantly, it’s more of a psychological benefit of being mortgage-free sooner, because being debt free is the ultimate freedom and it significantly reduces the financial stress of retiring. A decline in income after retirement does not really sit well with the requirement to continue large monthly mortgage payments.
Doug Hoyes: So those are three different arguments to pay down your mortgage as opposed to investing. So number two on your list is risk. If I’ve got a mortgage at five percent and I pay it down I automatically just made it five percent.
Vikram Barhat: Right.
Doug Hoyes: And I don’t have to worry about what my returns are going to be – you’re saying that if I pay down my RRS – or, sorry, if I invest in an RRSP I don’t know exactly what I’m going to earn.
Vikram Barhat: Yeah.
Doug Hoyes: Unless I’m putting it in a GIC with a guaranteed return, and if I do what are GIC rates now? Close to zero, right?
Vikram Barhat: That’s right.
Doug Hoyes: You’re not making much there. So –
Vikram Barhat: In some cases you have negative returns on them.
Doug Hoyes: Yeah, and you’re saying negative returns because of inflation?
Vikram Barhat: Inflation, that’s correct. When you adjust it against inflation you’re actually making less than you’re investing.
Doug Hoyes: Because if the inflation rate is 2 percent and I’m only earning 1 percent interest then I’m really losing 1 percent in real terms.
Vikram Barhat: That’s correct.
Doug Hoyes: And you’re saying that when I pay down my mortgage, whatever the interest rate is that’s what I’m earning – and we’re talking after tax dollars so it’s actually–
Vikram Barhat: Mm-hmm.
Doug Hoyes: – an even better thing. Now you said the psychological benefit was number three on the list, so explain what you mean by that. What do you mean the psychological benefit of paying it down?
Vikram Barhat: I think debt of any type, shape or form weighs heavily on your mind. It’s something that interferes with your day-to-day functioning, with your future planning, with your current spending, and it has far reaching consequences. So I think mentally it’s very important for people to be debt free as soon as possible, and particularly when you’re in retirement that’s the last thing that you want to worry about, because you have declining income, you’re making many lifestyle adjustments as it is. The last thing you want to do is just carry the debt burden and not knowing how to pay debt, or if you pay that debt, how to have enough money for your day-to-day expenses.
Doug Hoyes: Well, I know that one of the people you interviewed when you wrote the article we’re talking about – and I’m going to put links in the show notes to it – was Jonathan Chevreau, who has been on this show. And I know when I talked to him I think he told me the same thing he told you, which is when you retire you definitely want to be debt free. And that’s because of what you just said, right? Your income is going to be lower in retirement –
Vikram Barhat: Mm-hmm.
Doug Hoyes: – you want to have your expenses lower in retirement, too.
Vikram Barhat: Mm-hmm.
Doug Hoyes: So that’s not just a psychological reason, that’s obviously a very tangible reason, then, too, right? To make sure you pay down that debt.
Vikram Barhat: Oh, yeah. It stands to logic and reason, and obviously it’s a well thought out decision, which stands to reason and logic, really.
Doug Hoyes: Cool. But what I’d like to do is take a quick break and I got a few more questions related to this. Like what about taxes when I start paying down mortgages or investing in RRSPs? Isn’t it better to be putting money in an RRSP because of the tax implications, and so on and so forth? So I’d like to talk about that if you can stick around. Let’s take a quick break and we’ll 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 Hoyes: We’re back on Debt Free in 30, and we’re talking about the decision to invest or pay down debt. So if I happen to get a Christmas bonus, a summertime bonus, if I’ve saved some extra money, what should I do with it? Should I pay down my mortgage or should I invest it in my RRSP? So before the break my guest, Vikram Barhat – did I get your name close to correct, there, Vikram?
Vikram Barhat: Spot on.
Doug Hoyes: Spot on, that’s very good.
Vikram Barhat: [Laughs]. Good job.
Doug Hoyes: So, before the break you said here are some reasons why it’s better to pay down debt, including reducing your risk, reducing your stress, obviously there’s some financial reasons as well. Well, argue the other side of the equation for me, though. Are there reasons why it would be better to be putting money into an RRSP as opposed to paying down debt?
Vikram Barhat: Yes. And when you talk about tax implications, which is one of the factors that you have to consider when deciding between one or the other – and before I talk about tax implications I just want to take a minute to clear some confusion that seems to persist about the tax treatment when it comes to RRSPs. An RRSP isn’t a tax deduction plan but really is a tax defer program. RRSPs work like this. The government allows you to contribute up to 18 percent of your earned income from the previous year to an RRSP. You are also allowed to deduct that amount from your income. That means, depending on your income, you may get a tax refund after you’ve filed your tax return and [unintelligible 00:11:13].
Now, you won’t have to pay any tax on the capital gains dividends or interest these investments earn until you make withdrawals from the account. By then, hopefully, you’ll have retired and most likely will be in a lower tax bracket. Now, for people in a lower marginal tax bracket, making an RRSP contribution offers much less bang for their buck. If they also withdraw from it when their tax bracket is higher it makes it even worse. Investing in an RRSP makes sense if the person is in a higher marginal tax bracket, when they make the contribution and therefore get a significant refund, and a low marginal tax bracket when they withdraw from their RRSP investment.
Doug Hoyes: So I think the key word you said there was the word deferral. So with an RRSP what I’m doing is deferring tax; I’m not necessarily eliminating tax. Which you’re right, I think that is a common misconception. “Well, I put the money in the RRSP I get a tax break, great”. But there’s two sides to that, obviously. Number one, I put the money in and what matters is what is my marginal tax rate. And when you say marginal tax rate you mean the tax rate I pay on the last dollar I earn, which is the dollar I’m saving by putting it in the RRSP. So if my marginal tax rate is 40 percent then putting a thousand bucks in an RRSP is going to save me 400 bucks in tax. That sounds pretty cool. But the second part that you just said is what also matters is what’s your tax rate going to be when you retire.
Vikram Barhat: That’s right.
Doug Hoyes: And you assume your tax rate’s going to be lower, but if your tax rate, for whatever reason, ends up being higher then it wasn’t such a great idea. Obviously you had the deferral and you were earning the income during the period when you weren’t retired that you weren’t paying taxes on, but then you end up paying it. So the key point you said, then, it’s a deferral mechanism if your marginal tax rate is low right now then an RRSP has less benefit to you. That’s what you said, right?
Vikram Barhat: That’s correct.
Doug Hoyes: And in that case, then, you’d be leaning more towards the paying down debt?
Vikram Barhat: Absolutely.
Doug Hoyes: And is there anything else about taxes we need to talk about with RRSPs? It’s a deferral and it’s based on your marginal tax rates – that’s your key point there, I guess, is it?
Vikram Barhat: Yeah, that about sums up the tax aspect of it, yes.
Doug Hoyes: Now, I guess the other factor if I want to contribute to an RRSP is I have to have RRSP contribution room. So you already quoted how it works – it’s 18 percent of my income from last year is what I’ll be able to contribute this year.
Vikram Barhat: Mm-hmm.
Doug Hoyes: And that carries forward indefinitely, does it?
Vikram Barhat: It does yeah.
Doug Hoyes: So do most Canadians have lots of unused contribution room, or has everyone already maxed out their RRSP?
Vikram Barhat: [Laughs]. In an ideal world, yes, but we don’t live in an ideal world, so unfortunately because most Canadians are struggling to save enough to fund their RRSPs we have a large – I mean, it’s really no secret that Canadians aren’t exactly contributing to their RRSP with a vengeance. And the reasons are obviously very clear; there’s just not enough money left over after paying all your bills and taking care of your debt obligations and stuff like that. So currently we have about $800 billion in unused RRSP contributions, according to Statistics Canada, and what’s worse is that it’s expected to jump to $1 trillion by 2018. And this ties into my previous comment about the situation getting worse before it gets better. As long as we have these high debt level situations that we’re dealing with, unless that improves people will just not find enough money to spare to invest in their RRSPs.
Doug Hoyes: Wow, so $800 billion, that’s with a ‘B’, 800 billion.
Vikram Barhat: That’s what it is now.
Doug Hoyes: That’s what it is now, and it just keeps going up each year.
Vikram Barhat: Yes, it’s going to be $1 trillion by 2018.
Doug Hoyes: Wow, so people have in general lots of room to contribute to their RRSP but what you’re seeing is, yeah, but I got a lot of debt and as a result that becomes the priority, I don’t have any extra money to be putting into an RRSP. Is that the explanation for why there’s so much unused RRSP contribution room?
Vikram Barhat: Oh, yeah, absolutely, no two ways about it. That’s one of the major reasons for the lack of uptake in RRSPs at this point.
Doug Hoyes: So back to our question about when I’m trying to make this decision, should I pay down my debt or should I contribute to my RRSP, does age have anything to do with it? So would the answer be different if you were young as compared to if you were older?
Vikram Barhat: Great question, Doug. Absolutely yes. For people near retirement, especially in the top tax bracket, it makes more sense to maximize their RRSP contributions. The tax refund is more compelling if you’re in the top tax bracket. But for younger people paying down debt is certainly a winner.
Doug Hoyes: And the reason it’s a winner paying down debt if you’re a younger person is time? You’re saving that much more in interest? Is that really the biggest factor there?
Vikram Barhat: That’s right. You’re saving that much more interest and you have plenty of time to start saving for retirement just because of the window of time you have ahead of you.
Doug Hoyes: So in general if you’re younger the paying down debt is where you’d start, then. So I guess when I’m younger I’m also just starting out in my career, my new job – does that have anything to do with it? Would your answer be different for somebody who is in a more risky job environment where you could lose your job at any time, or is that not as big a factor?
Vikram Barhat: Well, that certainly is a factor, absolutely, Doug. The level of job security dictates a lot of things in your life, and investing in RRSPs versus – the decision to invest in RRSPs versus paying off a mortgage is no exception. It’s certainly a no-brainer that those with risky careers may want to prefer the certainty of a paid for home and focus on the RRSPs in the second half of life. And I basically just wanted to go back to the part where I said for young people paying down debt it’s a certain winner because their marginal tax rate is lower. Again, it goes back to the tax aspect, that because they’re starting out in their careers their income is low and the marginal tax rate is low, so it certainly makes more sense for them to pay down their debt rather than building their retirement savings, and particularly adding to an RRSP account.
Doug Hoyes: And so the conclusion, then, is there really is no one size fits all answer.
Vikram Barhat: Yeah, that’s right. It will absolutely depend on factors like your salary, your age, your personal financial condition; some of these factors are definitely going to be instrumental in you deciding whether one makes sense for you over the other.
Doug Hoyes: But in general terms you kind of lean more towards, well, paying down debt is always a good idea. That’s kind of where you come down?
Vikram Barhat: That’s my personal opinion, for sure. I mean, I think as a personal finance writer you tend to naturally lean towards a debt free life, but that’s not to say that it’s not a smart and prudent decision for the vast majority of Canadians, mid to low income Canadians. It’s very important for them to become debt free going into retirement. Preferably before going into retirement, but at least by the time they retire they should be debt free and not having to worry too much about taking care of their debt, as well as looking for retirement income streams.
Doug Hoyes: Yeah, no, it makes perfect sense to me, I agree with being debt free as well. That’s why we call this show Debt Free in 30. I’m on the same page with you. Well, I really appreciate you joining me, Vikram, that was very good information. Thanks for being here.
Vikram Barhat: Well, thanks for having me, Doug, it was good to be on the show.
Doug Hoyes: Great, thanks very much. We’re going to come back to wrap it up in a minute. You’re listening to Debt Free in 30.
Announcer: You’re listening to Debt Free in 30. Here’s your host, Doug Hoyes.
Doug Hoyes: Welcome back. It’s time for the 30-second recap of what we discussed today. My guest today was Vikram Barhat, and we discussed how to decide whether to use extra funds to pay down debt or invest in an RRSP. Vikram gave three reasons why it may be better to pay down debt instead of investing. First, you greatly reduce the future interest you’ll pay. Second, RRSPs have an uncertain rate of return, whereas you know exactly what you save when you pay down your mortgage. And third, there’s the psychological benefit of paying down your mortgage and reducing stress. That’s the 30-second recap of what we discussed today.
So what’s my take on Vikram’s message? Well, I agree. As he said, every case is different and the decision may change if you are young or old, or if you have a less stable or more stable job, but in most cases being debt free is a wise decision.
That’s our show for today. This show is available on iTunes and other podcasting software, so you can listen on your computer or your smartphone and automatically receive our new show every week, for free. Full show notes are available on our website, including links to some of Vikram’s articles and details on how you can download the show, 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.
Let’s Get Started Segment
Doug Hoyes: It’s time for the Let’s Get Started Segment here on Debt Free in 30, I’m Doug Hoyes and I’m joined by Ted Michalos – my Hoyes Michalos co-founder. We’ve been talking today about whether you should pay down debt or invest in an RRSP.
So Ted, let me throw the example at that we’ve talked about earlier in the show: I just got a thousand dollar bonus and I’m trying to decide do I use it to pay down my mortgage, do I use it to pay down debt or should I put it in an RRSP, and obviously the decision is kind of easy to see. My mortgage interest rate let’s say is maybe three percent, if I put that money in an RRSP I’m going to get a tax break that will be pretty nice this year, depending on my marginal tax rate.
So should I always just default to putting it into my RRSP, and let’s start by talking about the mortgage example and then we can talk about other debts. But how would you do that thinking? What would be your thought process?
Ted Michalos: So if you’re asking me would I be better off to pay a thousand dollars down on my mortgage or put it in the RRSP, then I’m going to agree that probably putting it in the RRSP is going to make more sense at current interest rates. Assuming your rate of return in the RRSP is more than the three percent you get on the mortgage – and it will be, because of your tax refund – that’s probably the way to go.
Now the qualifier I want to put on that is, I think RRSPs are a boondoggle for the average Canadian, they’re just a waste of time and money.
Doug Hoyes: Cool, and why do you think that?
Ted Michalos: Well, most Canadians are not contributing the maximum amount and I get it, because it costs a lot of money to live. So what happens, you don’t have a large amount in your RRSP when you retire anyway, and so when you convert that RRSP into a RRIF and you get the monthly payment, what it does is, it reduces the money you’re receiving from the government in your pensions. Your Canada Pension is based on what you earned while you were working; the Old Age Supplement is something that they top that up.
Well, most of the people that we talk to, they haven’t got enough in their RRSP that it can make a significant difference, but what it does is, it draws down what they’re entitled to receive from the government. So instead of getting that OAS cheque, they get less of it or none at all, and so it just doesn’t make any sense, it’s not equitable, it’s not fair.
Doug Hoyes: So you are a believer then in what?
Ted Michalos: What you’ve got to do is figure out can you contribute enough to your RRSP that there’s a net win for you at the end of the day; are you going to get more than the OAS cheque that you would have been getting every month?
Because that’s too complicated for most people to do, the default answer is, pay down your debt, and pay down your consumer debt first; the credit cards that are eleven, twelve, eighteen, twenty-nine percent. Your rate of return on paying down a twenty-nine percent credit card, is better than throwing a thousand bucks at your mortgage.
Doug Hoyes: And there’s really no thought involved in that, that’s a no-brainer.
Ted Michalos: There isn’t, and in fact your bonus cheque is a perfect example. Anytime you suddenly come into some kind of windfall of money – a thousand, two thousand bucks, whatever it is – pay it down against the credit cards and the lines of credit. The most expensive debt, throw it at that first.
If you’re able to make larger monthly payments on a regular basis, you might decide to increase your mortgage payment, but my advice is still going to be, pay down the damn consumer debt; pay down the credit cards, pay down the lines of credit. The RRSP is one of those, if you can’t put enough in there, by the time you’re 65 or 69 or whenever you’re going to retire, then the RRSP was a bad idea in the first place.
Doug Hoyes: So consumer debt is a very high interest and so unless I’m going to earn twenty-nine percent in my RRSP after tax, it’s a no-brainer. The mortgage though- are you on the fence on that, or is it still a simpler decision to say, you know what eliminate the risk, pay down the mortgage?
Ted Michalos: At current mortgage rates, which I think TD’s best customer rate as of this week is 2.24%, it doesn’t make a lot of sense to pay that mortgage down if you’re carrying a credit card at twelve, fifteen, eighteen, twenty-nine percent; pay down the credit card first, because it’s costing you a lot more money.
Doug Hoyes: And is that better psychologically as well for you?
Ted Michalos: Yeah, I think you’ll feel better about it. And your house is still your biggest investment and over time you want to pay that down, but quite frankly, it’s costing you a lot of money to carry that credit card debt. Get rid of it and then cut up the cards, but I guess that’s another show.
Doug Hoyes: Another show for another time. And what about something like a car loan? Is that the sort of thing that well, it’s probably locked in and fixed, there’s really no need to worry about that? Or if that’s my only debt, is that something I should look to attack as well?
Ted Michalos: So if the comparison now is a car loan versus paying down a mortgage, the car loan has higher interest, I’d pay the car loan down first. If it’s a choice between mortgage, car loan, credit cards, pay down the credit cards first.
Doug Hoyes: So the thought process then is based almost entirely on the interest rate?
Ted Michalos: Yeah, what’s the most expensive thing to you, because what’s going to get you the best savings? Paying $1000 down on a credit card means you’re not paying twelve, fifteen, eighteen percent interest on that $1000 anymore. Paying $1000 off on the car loan at six percent, well, I mean, it saves you a third of what it saves you on the credit cards.
Doug Hoyes: And you’ve got to also look to see whether there’s any kind of prepayment penalties or something on a car or a mortgage or whatever. Obviously with a credit card or a line of credit, you can pay that off, there are no issues with that and it’s done.
Ted Michalos: Correct.
Doug Hoyes: So it’s pretty simple. Okay, so the answer then is, in general terms, paying down debt is always a good idea. You eliminate the risks, start with the highest interest rate debts and work your way back from there.
Great, thanks very much for being here, Ted. That was the Let’s Get Started segment here on Debt Free 30.
Debt problems are stressful. They are difficult to deal with as an individual and can tear apart adult relationships; so it’s pretty obvious why it may be tempting not to talk to your kids about your money problems. While your instinct may be to protect your children by keeping them in the dark about a difficult financial situation, it’s not in their best interest. Children are incredibly perceptive, and likely know that something is going on long before you decide to tell them. Keeping secrets may actually cause them to be more stressed and anxious.
Keep these tips in mind when talking to your kids about debt:
Be Honest
Making excuses for why there are suddenly fewer television channels or why the annual family vacation isn’t happening or why they can’t have the new laptop they’ve been asking for is a bad idea. You teach your children to be honest with you and that they can trust you, so you need to show them that it works both ways. Having said that, kids don’t need to know everything. So tell the truth, but spare the gory details for adult conversation.
Keep it Age Appropriate
If your children are elementary school aged or younger, use simple terms that they can understand. To them, the most important thing to know is that they’re still going to be loved and cared for and that it’s not their fault. To a young child, a family crisis such as a job loss or layoff may actually be good news as they get to spend more time with their parent while they look for new work. Try to avoid having emotional discussions or falling apart in front of your young children – save those moments (which you are entitled to have) until after bedtime.
Tweens and teenagers have a much better grasp on money and will be better able to understand cutting back. Don’t spend lots of time drawing their attention to things they can’t have or things they can’t do, instead, focus on ways the family can work together to balance the household budget. If you currently pay to have services performed such as mowing the lawn or babysitting for younger siblings, this is an opportunity for an older child to step in, do these tasks and “earn” some money (albeit less than you had been paying) – this not only helps to reduce the family budget, but also allows your child to feel like they are contributing and still able to have some spending money of their own. A big concern for older teens is going to be their ability to attend university or college. A frank discussion about what you will or will not be able to help them pay for is best for everyone and will help them to set realistic expectations for what their post-secondary education will be like.
Young adults are beginning to live at home for longer and they are apt to figure out there is something financially amiss. In this age category, it may be time to insist that they start to contribute to the household as well. Young adults look to their parents as financial role models, so let them learn from your debt troubles along with you so that they don’t end up in the same situation in the future.
Use it as a Teachable Experience
No matter what age your children, telling them about debt problems can be a wonderful chance to engage them and teach them about family finances. You may decide to implement spending jars so that everyone can see exactly how much is left to spend in any given jar at any time. You may suggest that a teenager look for a part-time job to help pay for the new jeans/shoes/video game/phone that they just have to have. It’s also a great opportunity to discuss the differences between want and need (a concept many adults still struggle with!).
Our children are woefully under educated about finances from the current education system. Coming together as a family to talk about and address debt problems can help to set them up with tools that they will use for the rest of their lives such as budgeting, accountability, and structure. This will significantly reduce the odds that they will experience financial distress of their own in the future.
Assure Them You Have a Plan
At any age, your kids are going to want to know one thing in particular – that it’s all going to be okay. A time of financial difficulty can be a chance for a family to pull together and meet challenges head on as a unit. And this is where we can help.
If your family is dealing with financial uncertainty or is having trouble meeting your minimum payments, you may benefit from having a free meeting with one of our trustees. We can review your debt problems and financial situation with you and help you to come up with a plan – the right plan for you and your family – to get you back on track.
Today on Debt Free in 30 I talk with mortgage agents Michael Smele and Bev Gay about whether it’s possible to buy a house after, or even during, a personal bankruptcy or consumer proposal. They each give their opinion about who can qualify for a mortgage and what options are available to individuals with poor credit.
The biggest take-away from our conversation about buying a house — saving up the biggest down payment possible will not only reduce your monthly payments, but it could also mean that additional insurance fees will not be included in those monthly payments.
Re-establishing credit for a mortgage
After a bankruptcy or proposal, your credit rating will not be high (but chances are, it wasn’t high before you filed). Both Michael and Bev talk about re-establishing your credit before taking on a mortgage.
Although it may take a few years, waiting while you improve your credit score will help with being approved for your mortgage and receiving a lower interest rate. They explain that lenders are looking to see whether you can responsibly manage a higher credit limit, to prove that you are not a risk.
Michael outlined in general what traditional lenders are looking for in order to be approved for a prime quality mortgage post-bankruptcy. In general lenders want
2 year timeline after discharge over which you have re-established your credit;
2 or more new credit facilities; and
approximately $3000 credit limit
Learn more about the 2+2+3 rule of credit rebuilding and what lenders want in our Free Online Video Course on Rebuilding Credit.
You can use a secured credit card to initially establish your credit but this is not enough to qualify for a mortgage. You will need to graduate into something like a Canadian Tire Mastercard or other easy access consumer credit card, and eventually into more traditional lending products such as small bank visa, mastercard, line of credit or car loan.
Bev also talked about two different aspects to credit score management – a history of making payments and re-establishing your ability to handle a higher credit limit.
what the credit bureau computer is looking for, is that you pay on time, every time, but the banks and CMHC are looking that you can manage a higher limit.
I suggest that, yes, maybe you have a $2000 limit, but we’re never going to go above maybe $100 because we’re going to use it just to buy gasoline, because that’s a budget item. At the end of the month it gets paid back, every month. The computer doesn’t track how much you spend; it just knows that you pay on time, every time. And the fact that you stay away from your limit also gives you a better credit rating.
If you have no credit now, Bev’s advice is to start with a small secured credit card and never approach the card’s limit. Even if you are not approved for a $2000 secured credit card, get a smaller limit and make your payments every month, on time. Your lender will see that you can carry a higher limit and you will eventually get to where you need to be to re-establish your credit. This process of getting your credit rating back on track will take time – it could even take a few years – but at least you’ll be able to achieve your end goal, the right way.
For more information about credit reports and credit repair download our free Credit Rebuilding 101 ebook.
So you’re in the process of re-establishing your credit and have put yourself in a better place to take on a mortgage, but don’t run out to your bank or mortgage agent just yet! Michael and Bev explain that a mortgage is possible at a 5% down but you will pay a cost in terms of mortgage insurance. Any down payment below 20% is generally considered a low down payment which will trigger mortgage insurance.
Twenty-percent is the ideal down payment because not only do you take a chunk out of your monthly mortgage payment, but you also avoid a mortgage insurance charge being tacked on your bill each month. when you have a low down payment mortgage, you pay the same rate to the bank as someone with 20% and similar credit, but you also pay an insurance premium on top of that. Michael explains this approach stating that,
the kind of inverse system that we have here is that when the risk is removed, the lender provides a better interest rate, but that comes with a mortgage insurance premium. So there is a bit of a Catch 22 there. If you want the best rates and not paying an insurance premium, you’re going to have to put down that 20%.
My advice? Although 5% down sounds tempting, I strongly advise listeners to save up as much as possible to build a better foundation for home ownership and the added expenses that it includes. Buy a smaller house if need be to maximize the down payment you can save. Much like credit card debt, where paying the minimum is a bad idea, paying the minimum down payment costs too much.
Final Thoughts
It might be hard to put off your dream of owning a home for a few more years, but it’s worth every second. I’m not suggesting that you give up on this dream, but rather, that you go about it the right way. Growing your savings with a financial goal in mind, such as buying a home, will put you in a better place to take on such a large financial expense. Make sure to consider all of the costs associated with buying a house including property taxes, utility costs and needed repairs; all in addition to your regular monthly expenses like groceries and child care. Home ownership should be well researched and planned, rather than an impulse decision that could leave you house poor.
For more information and real life examples about getting a mortgage after or even during a bankruptcy or consumer proposal, we recommend listening to the podcast with Michael and Bev. We discuss the topic in more detail and may answer any questions that you might have.
FULL TRANSCRIPT show #31 Michael Smele and Bec Gay
I know that whenever I talk to someone in financial difficulty and they realize they’re going to have to take drastic action to deal with their debts, one of the most common questions I get asked is, “Will I ever be able to buy a house?”. They worry that if they go to credit counselling or do a consumer proposal or a bankruptcy, they’ll never be able to qualify for a mortgage. That is a real concern.
Obviously, if you have bad credit it’s more difficult to qualify for a mortgage. So what does it take to qualify for a mortgage, and in particular, if you’ve had bad credit in the past? That’s the topic for today and I’ve got two guests who are experts in the mortgage industry to answer that question, one in each of my two segments today. But before we get into the nitty gritty of this topic, let me give my standard disclaimer.
Every guest on Debt Free in 30 is picked by me personally, and I’ve picked them because I believe they have important information to share with you, the listener. When I decided to do a show on mortgages I put the word out to my network and asked for names of mortgage experts that my team knows and have dealt with, and that’s how I found our two guests today. This show is not an infomercial for my guest’s services. My guests don’t pay to be on the show and I’m not paying them to be on the show. Our focus is to give our listeners practical advice.
So with that background let’s get started with my first guest. Who are you and what do you do?
Michael Smele: Hey Doug. My name is Michael Smele and I’m an active blogger, speaker and I’m also an advisor to a select clientele on their mortgages. What I do specifically is I provide them with the tools to navigate successfully the vast and quick changing financial landscape here in Canada.
Doug Hoyes: Cool. Well thanks for being with me Michael. So you’re a mortgage agent.
Michael Smele: Mm-hmm.
Doug Hoyes: I guess my first question then would be, why should someone looking for a mortgage talk to someone like you? I mean we all know banks give out mortgages; they advertise them very heavily. I assume the market is very competitive, so I assume I can get a pretty good deal from a bank. Why should someone go see a mortgage agent such as yourself?
Michael Smele: Absolutely. That’s a great question, Doug. Why should you use a broker? I’d say the number one difference between us and the retail level or how you acquire a mortgage is the level of service we provide. The way I feel a proficient broker or agent differentiates himself is in how they position themselves as a trusted advisor on your team, just like a CPA or having a realtor in your back pocket. And what we provide as brokers is strategies to help save literally thousands of dollars in mortgage interest over the lifetime of your mortgage. And where the rubber meets the road is in understanding the mortgage contract. How to navigate the terms and the fine print that a lot of times the banks gloss over or don’t even feel they have the need or the regulatory requirement to disclose to you.
Doug Hoyes: So I get that, you’re saying that you know the bank’s there to sell their product. You’re there to have a more long-term relationship with the person. You want to explain to them what the mortgage is, how it works and then you’re shopping the market to get them the best deal. And that all sounds – that sounds wonderful. It’s just a beautiful thing, but let’s be honest here. You are a private business person. Obviously, you are getting paid for your services so I assume that if I get a mortgage through you there’s some kind of fees that are built into the cost of the mortgage. So doesn’t that mean it’s going to cost more to get a mortgage through a mortgage agent than it would cost if I just went and got a mortgage at the bank?
Michael Smele: That is an interesting question and it’s a very commonly held, but incorrect assumption, that a lot of consumers hold. If we just take an apples to apples comparison here, Doug, and look at a mortgage that I arranged for my client at 2.9% and at the retail branch level at Bank A you’ve got a mortgage arranged for 3%. Effectively based on the cost of borrowing, the consumer wins. That’s it. Period. The way banks pay brokers on the – especially on the finder’s fee, is they actually pay us out of their profits to gain market share. And at the end of the day that is just considered a cost of borrowing. And what’s little and less known to the consumer is that banks actually pay other referral sources to gain market share as well, and that is also just a cost of doing business.
Doug Hoyes: So what you’re saying then is, if I’m a – let’s start with the simple example where I’m a Class A client. I’ve got you know, decent credit. I can probably get just as good or maybe even a better deal by going through you than I would if I just went to my bank and signed on the dotted line. Is that what you’re saying?
Michael Smele: Absolutely.
Doug Hoyes: Okay. So now let’s talk about the person who perhaps isn’t the greatest credit risk in the world. Somebody who perhaps has had some credit challenges in the past. Maybe they’ve gone through a bankruptcy or a consumer proposal. That process is now finished. They’re in the process of re-establishing themselves. They want to then get back into the housing market. What’s it going to take? And as I said off the top of the show, this is a common, common question that I get all the time. So let’s kind of break it down then. So let’s take that example. My proposal is done. My bankruptcy is done. How many years does it take before I’m going to be in a good position to quality for a mortgage? We know that if I go bankrupt, on Equifax for example, there’s going to be a note for six years that says, “I went bankrupt”. If I do a consumer proposal I know there’s a note for three years after I finish making all the payments. Does that mean I can’t get a mortgage for six years after bankruptcy?
Michael Smele: Right, and just a quick caveat on the bankruptcy or post-bankruptcy qualification. In the mortgage industry there’s so much flux in terms of negative and positive trending and where exceptions are made in extenuating circumstances. So just to kind of qualify that question, you can get mortgages post-bankruptcy that are not necessarily prime mortgages. But what we’re looking to do is to qualify for an institutional mortgage post-bankruptcy or proposal. So in generalities, what they are looking for is a two year time-line to lapse after your discharge. A two year time-line where you re-establish your credit from the date you re-established it to the time and date you talked to them.
And what’s left is obvious but they do look for approximately two plus new trade lines or credit facilities being established. What’s more or less not overt out there in the industry but suggested by a lot of lenders is that you also have approximately $2500 in new credit available to you. One thing just to advise people about that are going down this path, that there in no case are secured credit cards or those prepaid credit cards that people often use are going to assist you to this end.
Doug Hoyes: So when you say re-establishing credit then, and you threw out the number of $2500, and I know you said we’re speaking in generalities, obviously every situation is different. We’re kind of just trying to paint a picture here. What kind of things then would help re-establish credit that you’ve seen?
Michael Smele: So again if you’re looking at unsecured credit you are qualifying based on your own merits. So that’s where – I mean sometimes people are so bad they need a secured credit card just to get a footing. But once they have that footing and the credit starts improving through the credit cycle, sometimes it’s just as simple as starting with a small Capital One, Canadian Tire Mastercard. One of those easy entry-level consumer credit cards that may be providing you $500, $700, or $1,000 in available credit. From there we want to move back into a bank type of facility. Either a Mastercard, Visa, or a small line of credit. And then again it can be more organic. Sometimes people even through the proposal or bankruptcy have some surviving credit. A car loan maybe and that can give them some footing to help speed that process. So again, there’s no hard and fast rules here but these are the generalities.
Doug Hoyes: Cool, and so the final question I want to ask you then has to do with level of down payment. So let’s take the person who has perfect credit. They you know, fantastic, never been bankrupt, never done a proposal, everything’s fantastic with them. And they want to get a mortgage at the absolute best rates. They don’t want to have to pay any kind of mortgage insurance or anything like that. What’s the minimum level of down payment required in that scenario?
Michael Smele: Well if we’re not looking at mortgage insurance then today’s best rates are going to be on 20% down, because anything over and above – I mean you will still even get a better rate if mortgage insurance is involved because the risk is removed from the bank’s shoulders and put on – well it’s effectively put on the taxpayer, but don’t let anyone say that out loud. But the kind of inverse system that we have here is that when the risk is removed, the lender provides a better interest rate but that comes with a mortgage insurance premium. So there is a bit of a catch 22 there. If you want best rates and not paying an insurance premium, you’re going to have to put down that 20%.
Doug Hoyes: So 20% if you’ve got perfect credit. Somebody’s who’s got less than perfect credit, but is willing to pay the insurance premiums, what’s the absolute minimum you can get away with then in terms of a down payment?
Michael Smele: It’s the 5% down payment through mortgage insurance. It’s still possible for those people if they met the minimum requirements. Just quickly as a caveat, self-employed people will not. So unfortunately, regardless of their re-established credit, post-bankruptcy they are just not a candidate.
Doug Hoyes: It’s more difficult. Okay good. So 20% if you’ve got perfect credit. It is possible to get mortgages with a little as 5% down. Obviously you’re going to pay a little bit more for that. I appreciate that. Thanks very much, Mike. We’re going to take a quick break and come back and talk more about mortgages right here on Debt Free in 30.
Speaker: You’re listening to Debt Free in 30. Here’s your host, Doug Hoyes.
Doug Hoyes: Welcome back. On today’s show we’re talking about mortgages. I want to make sure we aren’t hearing just one perspective so in this segment I’ve got another mortgage professional to help us understand how to qualify for a mortgage. So let’s get started. Who are you and what do you do?
Bev Gay: Hi Doug. I’m Bev Gay. I’m with The Mortgage Group and I’ve been a mortgage professional for 15 years. I’ve closed over 15,000 mortgages in my time and I pride myself in looking at every situation and trying to find the best contract or mortgage product for their particular needs.
Doug Hoyes: And before you were a mortgage agent where did you work, what did you do?
Bev Gay: I worked – I was a mortgage banker and I loved that. And then I went to work for CMHC and for Genworth. So I have a pretty good perspective on all aspects of the business.
Doug Hoyes: And what is CMHC? What do they do? What’s their role in the mortgage world?
Bev Gay: CMHC is known as the government mortgage insurer. So they insure mortgages to the banks and basically you pay a premium in the mortgage payment for that but it allows you to get a low down payment mortgage.
Doug Hoyes: And so I need to get mortgage insurance at what level of down payment?
Bev Gay: Normally, we say if you have less than 20% down payment.
Doug Hoyes: Gotcha. So if I’m getting a mortgage with 10% down, 5% down, 15% down there will probably be – almost certainly there will be CMHC insurance that the bank will in effect, tack onto the mortgage. Makes the mortgage a little bit more expensive but that protects the bank and the bank probably wouldn’t have done the deal otherwise.
Bev Gay: That’s correct.
Doug Hoyes: So in order to get the absolutely best mortgage rate, I want to have a down payment of 20% or more. That way I can avoid the insurance. Is that a simple statement or is that not correct?
Bev Gay: You will get the same rate whether you have 20% down or 5% down. The down payment does not affect that. It’s just that you don’t have the insurance premium worked into your payments.
Doug Hoyes: I gotcha. So the amount – as a customer the amount I pay will be higher, because I’m paying the mortgage interest rate plus the insurance premium on top of it.
Bev Gay: Right.
Doug Hoyes: Okay. So in the first segment we were talking to Mike who is a mortgage agent as well and he was walking us through what’s required in general terms to qualify for a mortgage for somebody who has less than great credit. So I want to delve into that a little bit deeper with you, because that’s something you’ve got some expertise in. So let’s take the scenario of someone who has been through a proposal or a bankruptcy. As a result their credit is damaged and now they would like to start the process of buying a home. So I’m assuming that the day after my bankruptcy ends if I have zero down payment, I can’t just walk out and get a house. That’s kind of obvious right?
Bev Gay: Exactly.
Doug Hoyes: So what is it going to take then to get there? So let’s pretend I’ve come to you in that scenario. My bankruptcy or my proposal just ended and I would like to buy a house some day. So walk me through the specific advice you give me to accomplish that.
Bev Gay: Okay.
Doug Hoyes: What’s the first thing I want to do?
Bev Gay: Alright. Well every situation is a little bit different so I will just give you an outline average. The very first thing that we want to do is meet and determine sort of, where you could be and how we’re going to get you there. The very first thing I want to do with you, is to get your credit re-established. Some people try to do that on their own and end up doing it incorrectly or they go bank to bank to bank and have lots of credit checks on them and that actually is more to their detriment.
Doug Hoyes: Yeah, because every time your credit is checked there’s a note on your credit report you went to twelve places and they all turned you down. That’s going to make it worse. So you’ve got to do this smart then. So okay, I want to start re-establishing my credit, what’s a specific thing I can do then?
Bev Gay: First thing we do is get you a secured credit card. And to be honest, if we have to start at $500 then we do that.
Doug Hoyes: Now just let me interrupt you there cause on our first segment Mike said that, “You know what? A $500 secured credit card is really not going to make a whole lot of difference.” Do you agree or disagree with that?
Bev Gay: I totally agree. Nowadays to get a mortgage they’re looking for actually two items with re-established credit with limits of at least $2000 or $2500. So even though you can only maybe get that $500 initially. After some series of payments, most often 12 months, then they will increase the limit to $1000 or $1500. If you are able to secure more, then we can get you a higher limit. Because what we’re looking for and what the credit bureau computer is looking for, is that you pay on time every time but the banks and CMHC are looking that you can manage a higher limit.
So I work with you very closely on how we use that limit. So I suggest that yes, maybe you have a $2000 limit but we’re never going to go above maybe $100 because we’re going to use it just to buy gasoline, cause that’s a budget item. At the end of the month it gets paid back every month. The computer doesn’t track how much you spend, it just knows that you pay on time every time. And the fact that you stay away from your limit also gives you a better credit rating. So doing that, it’s steps, but it’s steps getting you to the right place, which is buying your house.
Doug Hoyes: So what I’m shooting for then is history of making my payments, and I’m shooting for re-established credit, a couple of thousand dollars, three thousand dollars whatever, and then obviously I have to shoot for a down payment. So as talked about earlier, to get the best rates to not have to worry about any kind of insurance or anything, I’m shooting for 20%. But it is possible to get a mortgage after a proposal or a bankruptcy with as little as how much down?
Bev Gay: Really with as little as 5% down.
Doug Hoyes: With as little as 5% down, and obviously I’m paying the insurance fees and everything so it’s going to be a little more costly than if I had a larger down payment. So then, the final step in that process then is to save money. Is that correct?
Bev Gay: Right. And there is a “but” to that whole 5% down. It might take us four to five years to get there, but at least you’re going to get there.
Doug Hoyes: So if it’s going to take – so that’s my target then. I’ve got to get to at least 5%. Obviously more is better. How much is the house going to cost? How much is 5% of that? Do the math backwards. How much can I save every month? If I’ve got a fantastic job or if my mother is willing to give me a whole chunk of money, how quickly can I then buy a house after a proposal or a bankruptcy?
Bev Gay: It could be one day, one month.
Doug Hoyes: If I got the bucks I can do it quicker.
Bev Gay: That’s right or a good co-signer. Lots of different things come into the scenario.
Doug Hoyes: So there are ways to do it. So the key point is a proposal or a bankruptcy does not mean you can never buy a house again.
Bev Gay: Correct.
Doug Hoyes: You just got to be smart about it.
Bev Gay: That’s right and it takes work.
Doug Hoyes: It takes work, yeah. I think that’s a key point. So final question I want to ask you in the last minute or so we’ve got here, what about the person who is in the middle of a consumer proposal right now? A lot of people do proposals because they own a house, they’ve got a little bit of equity, they don’t want to go bankrupt because they would lose it. Is it possible to borrow money against your house while you’re in a consumer proposal to pay out the proposal?
Bev Gay: Yes and the way that works is basically the government put a new rule on this year that you can only finance 80% of the value of your house. So we look at what the existing mortgage is, and how much money we can give you. If you’ve been in the proposal for 12 months, good repayment, then we can sometimes pay out that proposal and maybe there’s something else you want; you need a car or something like that. We’ll put you with a lender that is not a bank, but will give you let’s just say for example, 3.99% because you have you know, two more years to establish credit. And then in two years we can take you out to a mainstream lender.
Doug Hoyes: So it’s actually possible in the middle of a proposal if you have equity, to get a re-financed mortgage at a relatively good interest rate. We’re not talking 20%.
Bev Gay: Absolutely.
Doug Hoyes: We’re talking –
Bev Gay: – we have lenders who are going to help you re-establish yourself.
Doug Hoyes: Because they’ve got a customer for life now probably. So you mentioned 80%. So just so that we’re all clear cause before we said, “If I’m going out to buy a house I can buy a house with as little as 5% down”, but on a re-finance there has to be 20% equity. Is that correct?
Bev Gay: Yes. Now sometimes we do do private seconds behind and some of the lenders will let us go up to 85% or 90% –
Doug Hoyes: – gotcha –
Bev Gay: – with the private second behind.
Doug Hoyes: But there’s a difference between buying a new house and refinancing.
Bev Gay: Exactly.
Doug Hoyes: Excellent.
Bev Gay: And CMHC of course will not involved in any payouts of consumer proposals or things like that. So we have to have the equity or do a first and a private second.
Doug Hoyes: Gotcha. Excellent. Well that’s great Bev. I really appreciate you joining me today. What I’m going to do in the show notes which people can find at hoyes.com, is put links to your website so they can see how to contact you if they’ve got questions about how to re-finance because they are in a proposal or they want to re-establish and buy a house in the future, how to do it they can contact you. Thanks for being here today.
Bev Gay: Sure that’s great, Doug. Thank you.
Doug Hoyes: Great. Thanks, Bev. We’ll be right back to wrap it up. You’re listening to Debt Free in 30.
Let’s Get Started Segment
Doug Hoyes: It’s time for the Let’s Get Started segment here on Debt Free in 30. Today we’re talking about mortgages and I want to get some actual stories of real people who have gone through this process. My guest today is Mike Smele. Did I say that right Mike? Did I get your name right there?
Michael Smele: You did.
Doug Hoyes: Excellent. Very good. So we talked earlier about what you need to do to qualify for a mortgage if you have finished a proposal or a bankruptcy. Tell me an actual real-life story about somebody who you helped who had gone through either a proposal or a bankruptcy and was then able to get a mortgage through you. Tell me what happened in that case.
Michael Smele: Absolutely, Doug. I actually have a great story. It’s one that I’ve recounted to other clients over the years so this one’s great. I had a couple in Brampton. They were post their discharge of a consumer proposal and it was actually about three to five years. This is going back. The main obstacle that they had was their wrong or misperception about their financial future. They had in fact been rejected by their bank at one point after their discharge and for them they felt that there was no hope. So in asking questions and getting the scenario, we were actually able to ascertain that they had strong employment. Their credit was re-established by their own efforts and we were able to get them a great fully featured best-rates mortgage. And the effect was actually, there were tears. They had so much relief over the fact that they were able to you know, revise their financial plans for their future. But it was quite emotional. So you know I just want to give other listeners hope that you know, if the bank has rejected you in that sense, you’re not out of options. We don’t have to go to a loan shark. There’s a lot of options in between that, that can give them a good plan for their future.
Doug Hoyes: So the answer is, yes, it is possible after finishing. And was this a proposal or a bankruptcy that these people had gone through.
Michael Smele: It was a proposal.
Doug Hoyes: So after finishing a proposal, it is possible to get a mortgage and in their case it sounds like they did it in a prudent manner which is, they didn’t try to do it immediately. They saved up some money. They build up a down payment. They had good jobs and they also took some steps to re-establish their credit, and that’s why it was possible.
Michael Smele: Absolutely.
Doug Hoyes: So what about – you mentioned in the first segment we did today that it’s difficult to get a mortgage when you’re self-employed. It’s very difficult if you’re finishing a proposal or a bankruptcy, but in general it’s difficult to get a mortgage when you’re self-employed. And I assume the reason for that is when you go into the bank and they say, “Can you show me your T4 slip from last year?”, you can do it because you’re self-employed. Is that really the problem with being self-employed? So tell me again, somebody you’ve helped who was self-employed, but you were still able to arrange a mortgage for them.
Michael Smele: Absolutely, Doug. I’ve got a very recent example of a very successful gentleman, business-for-self or self-employed. And just like you said in the industry it’s very well known that proving the income or how the lender interprets the income is the issue. So we all work hard as self-employed individuals to lower our taxable income through legitimate methods, versus the actual income we derive from our businesses.
So this gentleman owned a restaurant with a partner in Markham. They had five million in annual sales but his two year taxable income or the average of that was about $33,000 where in actuality he was earning more likely a quarter of a million. So in this case our solution, because he had good credit, was that we were able to use a stated income mortgage product that, as long as it was in line with his industry standard, we were able to utilize that towards qualification.
And in cases where that’s not the case, there’s another example that you can actually use an industry standard of the 12 months business bank statements and that proves the viability of the business. And that’s another way that we can still get the mortgage if you’re self-employed. So these are just a couple of examples. But a quick tip for those who are business-for-self and are looking to move ahead or in the near future purchase a property. I’m going to tell them to keep their credit pristine and that’s specifically their credit score above six-eighty because if you don’t, your mortgage options will be seriously curtailed and that’s just a fact of the industry right now.
Doug Hoyes: So there you go. If you’re self-employed it is possible, but you have to keep your credit pristine is what you said. So don’t be late on anything and don’t mess anything up. And you hit on the key point with a self-employed person. If I’m self-employed, I’m going to do everything I can to keep my tax bill low. I’m going to make sure I’m recording every single possible expense that I can. That’s just natural. But of course by doing that, I am also therefore lowering my income and so then when I go to the bank, I’ve got lower income then what perhaps I would otherwise be incurring.
I mean as a self-employed contractor for example, I’m using my own truck to get to and from the job. So the business is paying for that. That’s an expense I don’t have to fully pay when I’m – that I would have to pay if I was an employee, but then that also makes my income look lower so that’s where the trick is. So you’re advice to people then if they’re self-employed is keep their credit pristine and then it may be necessary to get a special product like you talked about, but it is possible to get a mortgage if you are self-employed.
Michael Smele: Absolutely.
Doug Hoyes: Excellent. Well I appreciate that, Mike. Thanks for that advice. We’re going to put links to what we’ve talked about including to Mike’s website and his blog. You can find that at hoyes.com. Mike, thanks for being here today.
Michael Smele: Thank you, Doug. Appreciate the time.
Doug Hoyes: Great. Thanks very much. You’re listening to the Let’s Get Started segment right here on Debt Free in 30.
30 Second Recap
Doug Hoyes: Welcome back. It’s time for the 30 second recap of what we discussed today. On today’s show we talked about mortgages with my two guests, Michael Smele and Bev Gay. They both gave similar advice, it is possible to get a good interest rate on a mortgage after finishing a bankruptcy or consumer proposal, but it takes some planning and you do have to take steps to re-establish your credit. That’s the 30 second recap of what we discussed today.
So what’s my take on mortgages? What amazes me most of all is that as I record this show in the early spring of 2015, both mortgage experts told me that it is still possible to get a mortgage with only a 5% down payment, even if you have had a bankruptcy or a consumer proposal in your past.
My take is this. As we’ve discussed on previous shows, sometimes renting is the best option, but if you are getting a mortgage I still believe that a bigger down payment is better. At less than a 20% down payment you’re paying mortgage insurance fees which increase your monthly payments. So I think that in most cases it’s best to save for a bit longer so you can have a bigger down payment and lower your mortgage costs.
That’s our show for today. Full show notes are available on our website at hoyes.com. That’s h-o-y-e-s.com. Thanks for listening. Until next week, that was Debt Free in 30.
Speaker: Thanks for listening to the radio broadcast segment of Debt Free in 30 where every week your host Doug Hoyes talks to experts about debt, money, and personal finance. Please stayed tuned for the podcast only bonus content starting now on Debt Free in 30.
Podcast Only Segment
Doug Hoyes: It’s time for the podcast only bonus content here on Debt Free in 30. I wanted to hear some real-life stories from mortgage agent, Bev Gay. So I’ve invited her back for a few more minutes.
Bev, I’d like you to talk to me about some specific examples you’ve had helping people. And let’s start with the common example of somebody who in the past was bankrupt and then wants to buy a home. So tell me the story of someone in that situation you’ve helped. What did you do?
Bev Gay: Okay thanks, Doug. I’ve had many situations but I think sometimes the best one that I have was somebody that they were both bankrupt previously and then got together and decided that they wanted to see how to buy a house. And fell upon me through their real estate agent and I went and met with them a number of times. We set them up on budget first of all so we could get that secured credit card, which we did. And then they continued that budget to save for their down payment. Now after last summer, after almost five years of doing the budget and saving, they were actually able to buy their first home with 5% down, at a very, very good interest rate through a bank.
Doug Hoyes: So in their case you worked with them for a period of time. They had to save some money, but they were eventually able to accomplish their objective. So what about the situation where someone has done a consumer proposal and at the end wants to then buy a house? Have you got any stories like that?
Bev Gay: Yes. I’ve done that a number of times and sometimes it’s good to get prepared ahead of time. I have a gentleman right now who has pretty good job. His consumer proposal was due to a marital split and we are preparing for payout of the consumer proposal, refinance of his home over a three year rate of 3.99 so that he can establish his credit again through his mortgage, which now reports on the credit bureau. And at the end of the three years, we’ll be able to move him to a typical bank mortgage and if rates are down, at a lower rate.
Doug Hoyes: So you hit on a couple of key points there then. So first question about mortgages reporting on credit bureau. Is that a relatively new thing?
Bev Gay: It is very new. January this year.
Doug Hoyes: So January of 2015. So prior to that your mortgage didn’t show up on your credit report. Now it does, and that obviously has some impact on your credit score I guess or at least your-
Bev Gay: – yes, yes –
Doug Hoyes: – credit rating, your credit ability then.
Bev Gay: That’s right.
Doug Hoyes: So actually having a mortgage and paying it, very important. You don’t want to mess up your credit report by doing that. So back to this guy then who had done the consumer proposal. What – and I think the other key point you made was that there’s some planning involved here.
Bev Gay: Yes, of course.
Doug Hoyes: So you started working with this guy even before his proposal was over?
Bev Gay: Yes, mm-hmm.
Doug Hoyes: And so what kind of advice were you giving him then. “Okay so your proposal is going to end. Here’s what you should be doing now.” What kind of things were you telling him prior to the proposal even ending?
Bev Gay: Well basically we do do a credit check to see how things look there. They might be carrying a car loan through it, or not. Sometimes they do and then we just look at what he can afford, what’s realistic. We review bank accounts, make sure there’s no cheques bouncing, things like that because those are the type of proofs that will have to be supplied. So we make sure that all the ducks are in a row before you know, any kind of an agreement to purchase a home in entered into.
Doug Hoyes: And what kind of timelines in this guy looking at from when his proposal ends to when he’ll be able to actually finance a home?
Bev Gay: This one actually he’s got equity in his home, so we’re looking at probably a month to two months. Maybe three after he’s out of –
Doug Hoyes: So he’s got an existing home you’re going to be refinancing or he’s going to be buying a new home?
Bev Gay: Right.
Doug Hoyes: Is that what you – ?
Bev Gay: – no he’s going to be refinancing actually.
Doug Hoyes: He’s going to be refinancing. So with –
Bev Gay: – we’re probably going to pay out the consumer proposal. It has to run for 12 months with good repayment before we can pay it out.
Doug Hoyes: So it is possible to pay out a consumer proposal, while you’re in it, if you have equity and if at least 12 months has gone by. That’s the lenders that you’re dealing with now.
Bev Gay: That’s right.
Doug Hoyes: And if that works, then that works. Okay good. Great. Well I appreciate that. There’s a couple of stories. So I guess the message you’re giving people is it does take a bit of work. You do have to have a plan, but it is possible after a bankruptcy or a consumer proposal to buy a house.
Bev Gay: Correct.
Doug Hoyes: That’s pretty much how it works.
Bev Gay: And the worst thing you can do for yourself is go to the bank to apply, because it’s just going to be discouraging if they’ll even talk to you.
Doug Hoyes: You would rather they come to someone like you so that you can map out a plan to make sure your credit is rebuilt. You’re the one checking the credit reports, doing all that, and then they’re good to go at the appropriate time.
Bev Gay: That’s right. My job is to know which banks will do what products for what type of people.
Doug Hoyes: And that’s the whole point of using a mortgage agent. Excellent. Well I appreciate that Bev. That’s good advice. Thanks for being here today.
Finance companies are offering loans to people who are in a consumer proposal. The pitch can be, “use your car or house as security for a loan to pay off your consumer proposal.” We’ve also seen the entrance of new players into this space, including a new FinTech company Marble Financial, offering to help people in a consumer proposal rebuild credit with a Marble Financial Fast Track Loan to payout a consumer proposal early.
Is this a good idea? Perhaps, but only in very specific circumstances.
Advantages of Borrowing to Pay Off a Consumer Proposal
Improved Credit Report
A note indicating you filed a consumer proposal will remain on your credit report for three years after you make your final payment, or six years in total (on your Equifax credit report). If your proposal takes five years to complete, the note remains on your credit report for a total of six years. If you can borrow to pay off your proposal after two years, the note disappears after five years, so your credit report looks “cleaner” much sooner.
Improved Credit Score
If you have debt and pay it on time, your credit score will generally improve. While you are in a consumer proposal you have no unsecured debt; by getting a loan to pay off your consumer proposal, you now have debt, and as long as you are making your payments, your credit score may improve.
Peace of Mind
By paying off your consumer proposal early, you know that there is no chance that you will default on your proposal payments. Federal law states that a consumer proposal is automatically annulled if you fall three months behind in your payments. By paying it off early, there is no chance that you will miss any future payments, and that’s great peace of mind.
Sounds great. So what’s the problem?
Disadvantages Of Using A Loan For Proposal Payments
High Interest Costs
The most obvious disadvantage of borrowing while you are in a consumer proposal is that your credit score isn’t great, so you are likely to pay a high interest rate.
Let’s assume you have $10,000 left owing to complete your proposal, and a finance company is willing to lend you $10,000, secured by your car or house. They will likely require a high interest rate to compensate them for the risk of lending to someone who has not yet completed their proposal. If the interest rate is 20%, is it worth paying an extra $2,000, or $4,000 or whatever it will take in interest and fees to pay off your proposal early?
Only you can answer that question, but always remember that there is no interest on your consumer proposal; so by borrowing you are paying more, perhaps a lot more, than you would pay to simply complete your proposal as scheduled.
Back in Debt
You filed a consumer proposal to eliminate debt. Do you want to go back into debt to finish your proposal early? Doesn’t that somewhat defeat the purpose of filing a proposal?
Higher Risk
By borrowing, you have now put yourself at risk of default. If you pledge your car as security, and you can’t make the payments on your new high interest loan, you now risk having your car repossessed. Is that a risk you are willing to take?
Credit Report
Equifax maintains information about most debts, the filing of a consumer proposal, for a maximum of six years. So if you are already four years into your consumer proposal, if you pay it off over the next year, the note disappears in another year (six years from the start of the proposal). If at the four year mark you get a loan to pay off the proposal, and it takes you a year to pay off that loan, the note about that loan stays on your credit report for six years, so you have “restarted the clock”, which may not help your credit score. Paying off your proposal early by accelerating your payments may be better for your credit score than taking on new debt.
Crunch The Numbers
Here’s my advice: You should only consider getting a loan to pay off your proposal early if there is a very compelling reason to borrow. Perhaps your parents are willing to co-sign a loan for you, and they can borrow at very low interest; so financially it makes sense. Perhaps you want to buy a house in a few years and you want to start rebuilding credit immediately, and for you it’s worth the extra interest cost.
That may be true, but let me give you a word of caution: Everyone (but you) makes money if you borrow. Obviously the lender makes money, but here’s something you may not have considered: your consumer proposal administrator (that’s me) also wants you to pay off your proposal early, because then I get paid early. A Consumer Proposal Administrator is paid a percentage of the funds that are distributed to the creditors, when the money is distributed. So, if you pay off the proposal early, the creditors get paid early, and I get paid early.
That’s great for me, but is it great for you? Again, only you can decide.
3 Better Ways To Pay Off Your Proposal Early
I agree that you should pay off your proposal as quickly as possible, but I’m not a big fan of borrowing to do it, because of the interest cost. Here are some tips for paying off your proposal early, with no interest:
Increase the amount of your payments. If you are currently paying $400 per month in your proposal, increase your payment to $425 per month. You probably won’t miss the extra $25, but you will pay off your proposal faster, with no interest.
Increase the frequency of your payments. Instead of paying $400 per month, switch to weekly payments of $100 (if you get paid weekly), or bi-weekly payments of $200 per month (if that matches your paycheque). Paying based on your paycheque frequency makes budgeting easy, you won’t miss the extra payment, and your proposal will be done faster.
Make a lump sum payment. Did you get a bonus at work? A tax refund? A gift? Use some or all of that money to make a one-time, lump sum payment to pay off your proposal faster.
We all worry about losing our job or having our hours reduced, so paying off your proposal early eliminates the risk that you won’t be able to continue to make your payments. Whether or not you should borrow to do it is up to you, but consider all options before incurring any additional debt.
Debt Relief Experts
