If you just earned a bonus from your employer or received an unexpected sum of money, how should you use that bonus if you also have debt? I talk with Scott Terrio and we outline what to prioritize to get the most bang for your buck. We also take a look at common mistakes people make when they receive a surprise lump sum of money and discuss the impact a bonus can have on a bankruptcy filing.
Table of Contents
9 Ways to Spend Your Bonus Wisely
It’s easy to get caught-up in the excitement of having extra cash. To make the most of it, Scott suggests thinking about the following priorities:
- Make sure you’re up-to-date on necessities like hydro, water and rent.
- Next, prioritize secured debt payments like your mortgage and car loan to avoid the risk that your secured creditor may take legal action to seize you home or car if you are behind on payments.
- Pay down high interest debt. When you prioritize repayment based on the highest interest rate first, you save on interest costs.
- Prioritize callable debts. A callable debt is a loan that can have its terms changed at any given time. Your lender can raise the interest rate or reduce your credit limit with little notice. Paying down variable rate loans is a good idea when interest rates are rising.
- If you have no unsecured debt, put your cash towards an emergency fund for unexpected life events.
- Consider making a bonus or extra payment on your mortgage or car loan.
- If your debts are under control, take full advantage of tax incentive savings programs like RESPs or a TFSA.
- Next think long term, consider putting any windfall in an RRSP for your retirement.
- If your debt and savings priorities are met, invest the rest.
Avoid Common Mistakes
A surprise bonus, while great, can impede your ability to be rational. Scott argues that not stopping to reflect is the most common mistake people make. Other errors to avoid include:
- Paying off a credit card, then reusing it. If you paid off a credit card with your bonus, cut up the card immediately after or at least lower your credit limit. This way, you avoid the temptation of using your credit card as debt again and racking up more balances.
- Spending the gross amount instead of net. Make sure that you’re only spending the post-tax amount of your bonus (the net income) instead of the gross. You might be told you’re getting a $1000 bonus, but after-tax, that amount might only be $700.
- Using the money as a deposit on a big purchase and taking on more debt. For example, you might be tempted to use the money to purchase new car. The problem with that is you are likely taking on more debt, rather than dealing with the debt you have.
- Paying one creditor over another. If you’re struggling to make even your minimum debt payments, we recommend you meet with a Licensed Insolvency Trustee before using your bonus to pay down a loan. The reason for this is to avoid favouring one creditor over another without solving the whole debt problem. A Trustee can help you be strategic with how to use your bonus to arrange a settlement offer with your creditors. If your bonus is large enough, you might be able to pay off all your creditors at once with a lump sum consumer proposal.
If You’ve Filed for Bankruptcy
Any income you receive during a bankruptcy filing must be reported, according to the Bankruptcy and Insolvency Act. This includes a holiday cash bonus. Depending on the amount you receive, it may put you over your monthly bankruptcy surplus income threshold. If this is the case, it would extend the length of your bankruptcy from 9 to 21 months.
However, you can prevent a longer bankruptcy filing by being upfront about your financial picture before you file. Your Trustee will likely ask you if you expect to receive any bonuses or raises in addition to your regular pay. If it’s determined that your income goes above the bankruptcy threshold, you might file a consumer proposal instead. With a consumer proposal, you make monthly lump-sum payments. Any extra money you receive throughout the year will be yours to keep with no effect on your filing duration.
For more a more detailed look at how to treat a bonus or unexpected cash, tune in to the podcast or read the complete transcript below.
- Should you use your bonus to pay off debt video on YouTube
- Straight Talk on Your Money book
- Scott Terrio Twitter
FULL TRANSCRIPT – SHOW 225 Should You Use Your Bonus To Pay Off Debt?
Doug Hoyes: If you are one of the lucky ones who gets a year-end bonus at work, what should you do with it, or what if you get a large cash gift for the holidays, or a tax refund in the spring? What should you do when you receive a big lump sum of money? Now, of course, this show is called Debt Free in 30 because my guest and I discuss strategies to get out of debt, so the obvious answer to the question is: Well, if you get some extra money, use it to pay off debt.
It sounds like an obvious answer, but it’s not quite that simple. There may be some tax consequences if you get a bonus from your employer so you may not be able to use all of that money to pay off debt. And if you have more than one debt, which one should you pay off first?And what if you’ve already gone bankrupt and then you get a bonus, how does that work? Lots of questions, so to discuss it I’m here in the Hoyes Michalos office in downtown Toronto at the corner of Young and Bloor, and I’m joined by our manager of Consumer Insolvency, Scott Terrio. Scott, ready to talk money and debt?
Scott Terrio: Yes, definitely.
Doug Hoyes: Okay, so let’s start with the hypothetical questions here. So, one of our listeners calls you up and he says, “Hey, good news,I got a year-end bonus, but I’ve also got some debt.” So what’s your thought process on how to deal with that? What’s the first thing to think about?
Scott Terrio: Right, I think you and I have met with enough people over the years to know that this kind of thing actually happens.
This kind of thing happens,and it’s not necessarily always a Christmas bonus, but it’s someone who falls into money. So I think one of the things that people don’t do is pause and reflect on, okay, what should I be doing with it? What’s the maximum I can make of this sum of money? So, you know, consider your options, think about what you’ve got and what you need to address in some kind of priority, and then make a plan with it, because often times we’ll see people make mistakes by doing something impulsively, and oftentimes,too, that kind of stuff can’t be undone very easily.
Doug Hoyes: Yeah, I got some money so I’m going to pay off that guy because he’s the one who has been calling me a lot.
Scott Terrio: Yeah, or the amount of money I just got matches that exact debt and wouldn’t it be nice to just clean that one out? Not necessarily always the best thing you can do.
Doug Hoyes: Yeah, and I’d like to talk about how you figure out which one. So, the first thing that occurs to me, then, of course,and of course I’m a chartered accountant, a CPA, so if someone says I got a bonusand the first thing I’m thinking about is, “Oh, well, you’re going to get hit withtaxes.”
Scott Terrio: Mm-hmm, yeah.
Doug Hoyes: And so just because the boss says you’re getting a $5,000 bonus doesn’t mean you’re going to have $5,000 in your pocket at the end of the day. So how does that work? Tell me a bit about taxes when you’re getting a bonus.
Scott Terrio: Okay. So, if you do get a bonus– and let’s use the Christmas bonus as a good example because that’s maybe the most common one – it’s usually not always the same amount, first of all, because it’s based on whatever, you know performances and whatever, so it might not be exactly the same every year and you’re getting aid gross, before tax, so you don’t want to be spending gross because there’s always tax to come later. So your employer tends to know what your regular salary is, whether annual or monthly, and they’retaking off appropriate tax, but then the bonus, if it’s significant enough, could kick you up into another tax bracket, which means later on you’re actually going to end up paying more tax on your overall income.
So very important – as you said – to understand what you’re actually going to end up with net because you don’t want to be spending money that isn’t yours.
Doug Hoyes: Yeah, and you hit the nail on the head there: It may kick you up into a higher tax bracket, so all year long you’remaking X number of dollars and that puts you in the 30% tax bracket so you’ve been paying 30% all year long, and then at the end of the year, boom, you get this other chunk. Well, that means … And maybe they do it right; they say, oh, you know, that’s a lot of money, we’re going to take 50% off for tax, but what it also means is all the money you’ve made all year should have been taxed at 35% and not 30%.
Scott Terrio: Right. So even though they were doing it right before, that extra amount now means that it’s subject to a higher bracket, regardless of whether they were doing it right before.
Doug Hoyes: Yeah, which is a huge problem, and we see that all the time here, and so you’ve got to do the math to make sure. You might say, okay, a $5,000 bonus, they gave me $2,500 and I know I get to keep that.Well, no, you might still have another $500 or $600 in taxes owing, so that’s a problem. So do the math so you know exactly what you get to keep.
Scott Terrio: Yeah.
Doug Hoyes: Now, what then do I do with the money?So I’ve got all this, whether it’s a lot of money or a little money, what’s the first thing I should be thinking of paying? Give us the order of priority here.
Scott Terrio: Right, and we’ve put together kind of generic list of priorities here, and it may not apply to everybody, but it’s something to go through and say, okay, because oftentimes people are also under stress when they’ve got debt so they’re not really thinking of everything clearly.
Doug Hoyes: Pretty much all the time.
Scott Terrio: Right, and so first of all anything that’s overdue – I mean if your hydro is about to get cut off you want to get that–
Doug Hoyes: It might be a good thing to pay.
Scott Terrio: Right. Like immediate utilities where it’s something you can’t function without and you’re behind, that’s got to be the priority. Second would be anything to do with high-interest debt. And, you know, this is kind of projected math, so people sit down and they say, what’s my most high-interest debt here? Well, if you’re paying 27% on a retail credit card,or if you’ve missed a payment on a 20% credit card, well, you’re already paying 27% now because you missed a payment and they bumped you up. Over time that’s going to cost you a lot of money that you don’t notice, and so putting a chunk down on that kind of thing will actually save you money down the road, but you might not feel it right now, and so it’s future money that you’re protecting by doing that.
Doug Hoyes: Yeah, and it’s not hard to figure out the math. If you’ve got $100 debt, if it’s at 27% interest you’re paying $27 a year and if it’s 10% you’re paying $10, so by paying down the $100 I’m saving$27 as compared to the other.
Scott Terrio: Yeah.
Doug Hoyes: So put all your debts in order of the interest rate and start by attacking the highest interest rate ones
Scott Terrio: Right, and don’t necessarily get lured into paying one off just because it’s the amount that can be cleared. Because again, if you pay $10,000 of $20,000 at super high interest and you leave the $1,000 or $2,000 sitting over here, you’re actually doing better for yourself even though you haven’t cleared the debt off. People like to clear debts but that’s not always the best thing to do.
Doug Hoyes: And we see that all the time. It’s psychologically, well, I only owe $500 to that one, let’s get rid of it. Yeah, but that one’s only a smaller interest rate.
Scott Terrio: It didn’t do you as much good even though —
Doug Hoyes: Maybe psychologically it felt better,but from a math point it didn’t make sense. So okay, so I start with whatever is overdue, if they’re going to shut my hydro off that’s probably the number one priority,and then I would go to my high-interest debt. So let’s say that all of my debts are relatively the same interest rate, so what would be the next thing I would think about?
Scott Terrio: Okay, so what we call callable or secured debt. So secure debt, of course, is car loans, mortgages, anything where there’s an asset tied to the debt where the lender has recourse by seizing that asset if you don’t pay. And so the lender if always going to be able to pay itself by doing that, but what you want to do is you want to make sure that you are paying down those debts as quickly as you can because that asset is not yours; if the you-know-what hits the fan that car that you’ve been working to pay down for years now, if you have trouble making payments and you miss two or three, or whatever that lender is kind of sensitive to, you’re going to lose that asset. So in other words, you’retrying to pay more so that the asset is owned instead of owed.
Doug Hoyes: Yeah, and that’s counter-intuitive to a lot of people, because they’re sitting there going, “Okay, wait a minute, my car loan is at 3% interest, so why would I even …? Or my mortgage, which is the lowest interest, why would I even consider pre-paying that?” And you hit the nail on the head again: If you get behind on your car payment they can take your car.
Scott Terrio: Right, no matter how much you’repaid up till then.
Doug Hoyes: Yeah, it doesn’t matter, they can take your car.
Scott Terrio: If you’ve paid for three years,too bad.
Doug Hoyes: Too bad, you lose it. So yes, we understand it’s probably the lowest interest rate you’ve got, which is what a car loan or a mortgage is compared to a credit card, but if you don’t pay there’s a bit risk that you can take it, so how much trouble would you be in if you lost your car or your house?
Scott Terrio: You’re protecting an asset, essentially,right, so —
Doug Hoyes: Now, again, we said at the beginning this is an order to think about. In your case you may say, “Well no, I’m going to prioritize these things differently.”
Scott Terrio: It’s just that’s something people don’t usually think about so they’re trying to bring that out into the open. And the discussions that you and I have with clients which people can’t see, we talk about that kind of stuff, right, we just say, “Okay, are you aware that this is a possibility?” It may not apply. You may not care: “I don’t care if they take my car.” Okay, fine, but at least know about it, right.
Doug Hoyes: You’ve thought about it. Now, we talked about both callable and secured. So secured, we understand what that is,it’s where something is attached to the loan, so a car loan, a mortgage. Callable:What does ‘callable’ mean?
Scott Terrio: Callable means the terms or the rules around that debt, like a line of credit. The bank can move the goalposts at any time, basically, so like an unsecured line of credit. Most people don’t quite realize that that’s open to whatever the whims of the bank are. Now, that doesn’t mean the banks are going to go and ask you for the whole amount, but it means they could change the percentage, they could change the payment terms, they could change the limits, right? And so, that kind of stuff, you’re subject to a lot of things that aren’t in your control.
Doug Hoyes: Yeah, and that’s an excellent way to describe it: They can change the goalposts. And we see that all the time, particularly-I mean we’re recording this at the end of 2018 and I think we’ll be seeing this a lot in 2019 as well.
Scott Terrio: Yes, this discussion will be up next year again.
Doug Hoyes: Well, I mean I had a guy a couple of weeks ago who said, yeah, my line of credit was 5% and now all of a sudden it’s 10%.
Scott Terrio: How can they do that?
Doug Hoyes: How can they do that? Well, because it’s not a fixed-term loan. If you have a mortgage where the rate is locked in for five years, then the rate doesn’t change for five years; the car loan doesn’t change.
Scott Terrio: The bank is not going to change the rules if they can’t.
Doug Hoyes: Right.
Scott Terrio: I can assure you the lawyers have checked this out.
Doug Hoyes: Yeah, they can do it.
Scott Terrio: So to say, how can they do that? Well, it’s on page four.
Doug Hoyes: Yeah, they do it. And so your line of credit you’re humming along, it’s only 5% and it’s great, and then all of a sudden it’s 10% and your payments have doubled. So by chipping away at your callable debt,or as you call it, the “move the goalpost debt”, that’s certainly a good thing to protect yourself for the future. So, okay, what would be the next thing, then? I mean, I guess we kind of hit on it with respect to secured debt then, right?
Scott Terrio: Right, so I think we attacked one of the biggest issues around personal finance in Canada, which is setting aside an emergency fund or savings. You know, from all the stats that I hear there aren’t many people in Canada who have a good substantial amount of money set aside just in case. And I think part of that is the debt culture, right, it’s: Okay well I can just always put this on my line of credit or my Visa if I need to take the dog to the vet. I had a $3,100 vet bill – not me, one of my clients – last week, and the guy said, well, I was going to come in and sign and I can’t now because I’ve got this. Now that would have been nice to have money, but of course he’s past that.
And so I think if you’ve done all those other things first you’re in a good position now to maybe open a separate account, and you direct X amount of dollars off your pay every time in there, and you don’t notice it and it doesn’t hurt as much.
Doug Hoyes: Yeah, so when you look at this priority,then, so you start with the overdue stuff, then the high interest rate debt, then the callable debt, the secure debt. Then you start making extra payments on your secure debt, your mortgages if you can’t pay them off, or make extra payment on your car loan. Once you’re debt-free, then that’s when you start building up for the emergency fund.
Scott Terrio: Yeah.
Doug Hoyes: It doesn’t make a whole lot of sense to me if you’re paying 27% on a credit card, to be putting money in a savings account–
Scott Terrio: And getting three.
Doug Hoyes: Or zero.
Scott Terrio: Or two, or one.
Doug Hoyes: Yeah, and then paying tax on it.
Scott Terrio: I saw the other day the high interest savings account, it was 3%.
Doug Hoyes: Yeah, that’s high interest, so they’re borrowing it from you at 3% and loaning it out at 20%. So okay, you set aside your emergency fund, so my debts are paid off, I’ve got a chunk of money sitting there,so what comes next from there?
Scott Terrio: Look to the future maybe. So,like, if you have kids in RESP, right, so take advantage of the government grant portions of those things, you know they’re pretty significant over time, and start is as soon as you can. So when I meet with couples and they have young kids and they have all this debt. Well, okay we’re going to do a proposal, get rid of the debt and then you’re going to get an RESP underway because you’re going to run out of time at some point for that to be as much as it can be for when the kid goes to school.
TFSA, a similar thing –I mean you can do a lot of things inside of a TFSA; you can have RSPs, mutual funds,or whatever way you want to structure it, but now you’re at a point where you’re looking down the road. So you do your immediates, real immediates – hydro – and then you do your interest rate. Okay, which ones are the worst? Get rid of those first. So we’re moving along in terms of stress level, because you’re at this point now where you’re saving for the future; you’re in a better spot.
Doug Hoyes: Right. Yeah, you’re going down the line. And a TFSA can also be used for your emergency fund.
Scott Terrio: Sure it can. It’s a bank account.
Doug Hoyes: Yeah, and with a TFSA you don’t want to be putting money in and out, in and out, in and out, because you’re using up your contribution room which gets restored the next year. We don’t want to get into all the details, but if you want to put money somewhere that it’s a little harder to get at then a TFSA would be a good thing. And a RESP – Registered Education Savings Plan – you’re exactly right: You can only contribute to them up to a certain age.I think it’s by the time they turn 16. So if you want to take advantage of those government grants you’ve got to do it earlier.
So then, okay, I’ve taken care of education and things like that. The next thing, I guess, would be thinking about retirement.
Scott Terrio: Yeah, so look further down the road. So the kids have gone to school, whatever, whatever, you’re going to work forever, but you’re going to retire at some point hopefully, so now you’re looking at RRSPs and LIRAs and that kind of thing, so a lot more time to your advantage with those things. But again, now we’re at that point, right, so okay we’ve taken care of the immediate problems, the debts with high interest. We’ve paid down the car loan so that it’s ours or whatever.
You’re setting aside a few bucks just in case, like they always say – a month or two worth of living expenses, $5,000 or $6,000, something like that. RESPs, education, that kind of thing; what’s the retirement plan? So if you don’t already have one, well you probably should be sitting down somebody and looking at that, like what age are you? Are you 35? Okay, well then you’ve got what? 30 years plus. The more years you’ve got the better for that kind of thing, so don’t wait, but again we’re blocking and tackling here, right?You’re not in a position to do that unless you’ve done those other things first,really, because at some point if you’ve got all kinds of high-interest debt that’seating away in the background and you want that out of the way first before you’re looking at this kind of stuff, right?
Doug Hoyes: So the retirement would be the …well, almost the final step. And then I guess the final step is, okay, if you’ve got your retirement fully funded then you’re just into general investing then.
Scott Terrio: Yeah, just make yourself some money now because you’ve got- I mean, your retirement fund can be part of that as well, so the last two can kind of be combined because most people will either have a fund manager who is- you know, the RSP and the LIRA is essentially they’re trading,they’re trading stuff in the background, or someone is for them.
But yeah, at that point if you’ve done all those other things make yourself some money if you are able to do that, if you have learnt how to do that kind of thing. But again, it’s priorities. I have people who are doing those last two things now and really they’re step one … Maybe not step one with the hydro being cut off, but step two for sure, right, and so it’s like, do you know what you’re doing here?
Doug Hoyes: Yeah, it’s deal with those debts first. So okay, I understand the general thought process then. You deal with the most urgent debts, then the highest interest rates debts, you work through your debts and then you start saving.
So of course this is the portion of the show where I plug my book. You know, we’ve got to do it every show: Straight Talk on Your Money. Myth number eight, starting on page 79, is that you should pay your small debts first because, as you alluded to earlier, that kind of gives you a bit of a psychological boost in eliminating debt.
Now, I called it a myth, meaning I don’t agree, I don’t think you should pay your small debts first. I don’t think it’s a good idea. What do you think?
Scott Terrio: Well, it does make some people feel better, and I think it gets down to what kind of person you are. I mean if one of them makes you feel good, fine, that’s great. I suppose … Some people don’t want to pay multiple bills, and, frankly, you and I benefit from that to a certain extent because a proposal is one payment and all of your problems are handled in one payment per month. If you’re not doing a proposal sometimes it’s better to have multiple things you’re paying, as long as you’re saving a bunch of money that you wouldn’t otherwise notice.
So yes, okay, you don’t want to pay five or six things a month because it always feels like somebody is on your back. But I’ve had people where if that suits them better, knock yourself out, right.
Doug Hoyes: Yeah, I mean the reason I put that in the book is math. And you already hit it, that your priority should be to pay the high-interest rate debts first because it’s going to save you the most money.Then you want to start attacking things like callable debts, or lines of credit where they can just bump the interest on you, and you’ve got a lot more security.But I get it, and I guess I would come down on the side that, okay, if it’s a $200 cell phone bill, fine, pay it off. Okay, you’d save more money by putting the $200 against something else but it’s not a huge enough number to worry about. So if it’s a really tiny little thing, fine. But otherwise, yeah, mathematically you are going to save more money by chopping away at the high interest rates.
Scott Terrio: If you’re paying the high-interest ones, like you’ve got to keep doing that, you can’t just pay and pay and pay and think, okay, well I’ve still got all these debts that I’m paying all the time, but you need to set yourself up on some kind of a plan, because that is paying off.Even though you might not notice it you’re preventing yourself from paying 25% on debt down the road and that’s a lot
Doug Hoyes: It’s huge.
Scott Terrio: That’s a huge amount of interest,right, so it’s discipline, right. So ignore the little debts maybe and just keep with the plan.
Doug Hoyes: But you’re right, you’ve got to understand how your brain works, and I get it.
Scott Terrio: Yeah, it’s a tough one to get around for a lot of people.
Doug Hoyes: It is, and so again, we’re giving our advice on how we would handle it, but you can make your own decisions to do it the way you want.
Okay, so we’re talking about cases where I’ve got all this money and I pay things off and I start investing, but the typical people we’re meeting with of course, they do not have enough to pay off their debts. So if you get a $10,000 bonus but, you know, if you have $10,000 in debt, great, you pay off your debt, you’re good. But what do you do if you get a $10,000 bonus and you’ve got $50,000 worth of debt? You know, then what?
Scott Terrio: Right, so then if I have someone in my office what we’re talking about at that point is what’s called either a lump sum or a partial lump sum proposal, because you’re trying to make that $10,000 go as far as you can. So in normal circumstances you can’t with creditors, as long as you go to your creditors one by one on your own, privately, and say I’ve got$10,000, how about I make a deal with all of you? That’s not very realistic for most people because you’re dealing with separate banks, they all have to say yes,they’re all going to ask you for different things, they can change their mind later,like it’s not legally binding.
Doug Hoyes: Yeah, and so what you’re talking about is an informal proposal where I call them up and say, so in that scenario I’ve got —
Scott Terrio: Here’s my $10,000 —
Doug Hoyes: Yeah, I’ve got five different debts,each of $10,000, but I’ve only got $10,000. So yeah, in theory you could call each of them up and say, look, here’s a couple of thousand bucks, take it or leave it.And if you’re a year and a half behind on your payments – you haven’t made payments in a year and a half – they may actually accept that, but if you are relatively current, you’re only a month or two behind, well there’s no way they’re going to say, fine, we’ll take $2,000 to pay off $10,000.
Scott Terrio: Like, the bank wants you to keep doing what you’re doing forever.
Doug Hoyes: They don’t want you to pay it off;they want you to keep —
Scott Terrio: No, and there’s nothing wrong with that, they lend money to make money; that’s the business they’re in. So there’s no incentive for them to say yes to that, and so that’s why we have a lot of people who will go, okay, I’ll go do that. Well, if you can do it, great. I have seen very little success through anyone even trying that kind of stuff. Even through a lawyer it’s hard to get that stuff done, just because the bank goes, well, here’s what you signed, pay it.
Doug Hoyes: Yeah, it works in very specific circumstances,the debts are old – maybe a year, a year and a half old – maybe you’re self-employed,you don’t have any assets, so the bank can’t be garnishing your wages or doing anything.
Scott Terrio: Or maybe the bank has offered it, right. Sometimes they’ll send you a letter saying, hey, here’s an offer to clear your debts. I mean that happens. But we’re talking about people who have $50,000 and $10,000 of it is here, ten of it is here, ten of it is here; it’s not even the same creditor.
Doug Hoyes: It’s very difficult.
Scott Terrio: That’s tough to manage for somebody privately.
Doug Hoyes: So okay, now you mentioned the term“lump sum consumer proposal”, so let’s break this down. So a consumer proposal –and I think listeners to this show have a pretty good idea of what that is, butit’s a deal
Scott Terrio: Yeah, and most, and almost all proposals that we file, and other trustees file, are just strictly X number of months,because that’s what people can handle, they don’t have $10,000. If you’re lucky enough to have access to this kind of money – and again you have $50,000 in debt– but you can still make that work, because a lot of times what we’ll say is either offer them $10,000, take it or leave it, and no payment plan. And sometimes – it depends who the mix of creditors are and your circumstances, or whatever – they might take that.
Doug Hoyes: And that’s what a lump sum —
Scott Terrio: Lump sum proposal – just what it says: You give them a one-time payment and your proposal is finished. A partial lump sum can also be clever, because if you give them, say, $5,000 and you want to keep $5,000 or you want to whatever, and then you make a payment plan with them for the rest, so a proposal can be five years. So usually what we’ll say is, you know, here’s $5,000 now to assuage you, and sometimes the creditors will take that because they’ve gotten a lot upfront and they don’t have to wait as long to get paid out the whole thing.
So that’s attractive to creditors, and it’s also attractive to people who don’t necessarily want to give the whole $10,000 because they finally have some money. Right? And so, okay, the creditor knows you’ve got the other $5,000 but as long as you’ve given them a chunk of money it’s kind of good faith. That works actually. And sometimes creditors will take less because of this, because they’re not waiting as long. So in other words,if you had just walked in with no $10,000 bonus and were just doing a cash flow proposal, so a month-by-month proposal, $200 or $300, or whatever, for five years,if you have that $10,000 the creditors might say, well normally we’d take $20,000 as the total payout because we’re waiting five years, but if you’re going to give me $10,000 right now and I can just write this off, they might actually do that,we’ve seen that.
Doug Hoyes: And what we’re giving you is examples,because every situation is different. There are some banks who say, no, all we care about is the absolute dollar value, so whether you give us $20,000 over five years or $20,000 today, it doesn’t matter to us; there’s no time value of money because we’re a bank and all our money is —
Scott Terrio: Right, because we do lots of these we will know by your mix of creditors usually. Okay, if you’ve $10,000 you get this mix, they’ll do it, and these guys, they won’t touch it. So that’s part of experience.
Doug Hoyes: And there’s no reason you can’t start by saying, okay, I’ve got $10,000, here you go, that’s the deal. They may come back and want more – okay, so it will be $10,000 plus I’ll also kick in $100 a month for the next five years or something like that.
Scott Terrio: Right, you start somewhere, because essentially a proposal allows you to kind of dip your toe in the water and say, okay, well I’m not sure what they’re going to say, but here’s an offer, and they come back and say we’d also like a little bit, we talk and we’d figure it out and see what works you.
Doug Hoyes: Yeah, and our approach is to offer a reasonable proposal to begin with. We’re not going in low-balling with some silly thing, but sometimes the creditors will come back and want a few extra bucks. Well,that may end up being how it works.
Okay, so you are the guy who goes on Twitter all the time and tells stories, often in the evening, so if you’re on Twitter in the evening you can “Story time with Scott”, and a lot of the stories you’re telling…
Scott Terrio: Fireside chat.
Doug Hoyes: There you go, “Story time with Scott”. And a lot of the stories are, you know, here’s what happens if you make the wrong decision; you know, frankly what my whole book is about too.
So what are the kind of mistakes that you see people making? Because if we can show people what the mistakes are in advance when it comes to paying down debt, then perhaps they can avoid them and —
Scott Terrio: We’re talking about when you have a lump sum, right?
Doug Hoyes: Yeah.
Scott Terrio: Okay, so if you fall into a sum of money – and let’s use the $10,000 again – usually what I see people do is they’ll pay … like, they don’t have a plan for it so they’ll just impulsively pay one. This one matches $10,000, I can completely eliminate that entire credit card with just a payment. The next mistake they make is not cutting that card up, of course, and then of course the card sits there all tempting and $10,000 clear on it as a limit,and so they run into circumstances and they run the balance up again. So that’s a kind of a double problem – a splurge.
I mean, they’ve been under debt pressure for three or four years, maybe they haven’t been working or something, wouldn’t it be nice to just buy myself something? I’ve seen people go on vacation when they owe $60,000 in credit card debts. Not advisable, but understandable.
Doug Hoyes: Yeah, totally understandable. It’s been a year or two, I lost my job — And finally it’s Christmas, I want to buy some stuff for my kids, whatever.
Scott Terrio: I mean, like, your book says that too, I mean this is emotional, right?
Doug Hoyes: What’s the name of the book?
Scott Terrio: I can’t remember.
Doug Hoyes: You forgot the name. Okay, we’ll look it up.
Scott Terrio: Straight Talk on Your Money. Yes, I’m looking at the back here.
Doug Hoyes: There you go, perfect.
Scott Terrio: But that’s the kind of thing you address in there, and when you meet with as many people as we have, you see it;people aren’t necessarily rational with what they do. So the trouble is once you’ve done something, again it’s hard to undo things when you finally make a plan with someone like us and you say, okay, well you paid that one, the rest of the creditors might not be too happy about that, so there are ramifications to this. Making a big purchase, we talked about.
Doug Hoyes: Yeah, I finally got enough money to get a car.
Scott Terrio: Yeah, did you need a car?
Doug Hoyes: Yeah.
Scott Terrio: So they get a car, great, so you’vegot $50,000 in credit card debt and now you’re paying for the car as well, you know.
Doug Hoyes: Yeah, because the $10,000 bonus you got isn’t enough to buy the car, but it’s a good down payment on the car —
Scott Terrio: Right, so now you’re financing–
Doug Hoyes: And you’ve actually got even more debt.
Scott Terrio: Right, yeah. Congratulations, it’s even worse.
Doug Hoyes: And that might be okay, but again if you sat down with somebody beforehand you’d look and see, okay, what is the smart thing to do here, using the down payment on a big purchase like a house or something and financing the rest, and then also expecting that the money will go longer than you thought. $10,000 sounds like a huge amount of money when you haven’t had any for two or three years, right, you’re just living month-to-month, for two, three years you’re just basically barely making ends meet – $10,000 is not tons, right?It’s great, but it’s not going to support you for like a year, so.
And again, as you said earlier, you don’t really have the $10,000 – it’s maybe $8,000 or $7,000 after tax, so careful not to spend what’s not yours.
Doug Hoyes: Yeah, and actually do the math. So you’re right; $10,000, we’re just using that as an example. Of course it could be any number, but it does sound like a huge amount. Well, what does it cost you to live every month? What’s your rent, your groceries and everything else? $10,000 is probably not ten years; it’s probably a number of months and nothing more.
Scott Terrio: Exactly, so don’t get too excited about it. I mean it’s great that you’ve got it, but again you want to sit down and don’t do anything, because it’s easier to undo when you’ve done nothing, right –you haven’t committed yourself to anything – and look at what the best mileage for that thing is for your particular circumstances, because everybody is completely different.
Doug Hoyes: Yeah, pause for five minutes, make a plan and do that.
Scott Terrio: Yeah, exactly, don’t do anything impulsively with it.
Doug Hoyes: Okay, so final question, and this is a little bit off topic and I don’t want to get into a big technical discussion here, but what happens if you get this bonus while you’re bankrupt? So our regular listeners will all know that while you’re bankrupt you have to send in copies of your pay stubs to the trustee every month, and if your income gets above a certain level you’ve got to pay more. And this is all set by the government; every trustee has the same rules, this isn’t our rule. It’s called “surplus income” – if you make more you’ve got to pay more.
So what happens if while you’re bankrupt you get a bonus, or a big commission cheque, some other lump sum of income, while you’re bankrupt? What happens?
Scott Terrio: So the bankrupt has a duty to inform the trustee of all income during the bankruptcy from whatever means, whether it’s an inheritance, a bonus, whatever; it’s income. So we through that into all of your income over the period of your bankruptcy and it may subject to you paying it back to a certain extent, or a percentage, because there’s a surplus income formula.And so if you’re already in a bankruptcy and you’re under the level that you’re allowed per month so that you’re not in a surplus income bankruptcy, and you get a $10,000 bonus, that might put you over the surplus income threshold that the government sets, because we average it out.
And so that $10,000 – which is really only maybe $8,000 – because we’re only interested in that income – would be thrown into the mix and we would divide it out into the number of months in your bankruptcy and you’re either surplus or you’re not, which means you’re either nine or 21 months. It just means you’re going to pay more and it’s not something that you just get to keep, you have to report it because it’s your duty to do so, and then we have to deal with it in the —
Doug Hoyes: Well, one of the questions that you and I both ask every single person we meet with is: So how does your income work?Are you expecting to get any bonuses? And some people say, no, I’m straight hourly,it doesn’t change, and other people will say, yeah, you know, we usually get a quarterly bonus, or an annual bonus, and I don’t know what it’s going to be yet. And I probe a little deeper: Well, what could it be? “Well, you know, last year it was $5,000.”“Okay, $5,000 was the cheque or $5,000 or …?” “No, it was after tax.” Okay, so we nail it down.
And then we can plug that in and say, well, okay, if you get an extra $9,000 over nine months of a bankruptcy that means your income is $1,000 higher every month, and so instead of being in a first-time bankruptcy where it’s only nine months, if you’re over the limit an extra year gets added, as you said.
Scott Terrio: Right, and surprises aren’t good in this business generally, so we try and build that in so that if the person knows they’re going to get the bonus it’s part of the income, like we’ve already addressed it where it’s not coming in later.
Doug Hoyes: So let’s take that case then. I come to you and I say, “Yeah, I make this much, I’m around the government limit, but I know that three months from now I’m going to get our year-end bonus and it’s going to be a fairly substantial amount of money.” So all of a sudden the bankruptcy is not looking so good, what can I do?
Scott Terrio: So then we would say, does this make more sense now to look at a viable proposal. Right? Because if you’re going to make that much money, you know, does it make sense to spend – I don’t know -$7,000 for the privilege of filing a bankruptcy, instead of maybe doing a $12,000 proposal or something like that with a better credit rating and all that stuff.So you try and build this stuff into the discussions right up front so that everybody knows everything possible and all the possible permutations before they sign anything,and in that way, as I said, you don’t want a surprise like that: If you know something already, deal with it at the time and make an informed decision.
Doug Hoyes: Yeah, and that’s one of the main reasons people do a consumer proposal instead of a bankruptcy. They think things are going to improve in the future, and getting a big commission cheque, a bonus,is a way of improving, so by filing a consumer proposal you’re locking in the payment and right now you know exactly what —
Scott Terrio: Yeah, the creditors can’t comeback later and ask you for more. We don’t measure your income in a proposal, so if you’re in that situation, well, it probably makes sense to do it that way, yeah.
Doug Hoyes: It’s a huge advantage, yeah, and you probably feel better doing it anyway, so it makes perfect sense.
Okay, so what is your final advice then to everyone listening here? If you either have got a bonus or think you’re going to be getting a bonus or any other kind of lump sum of money, what do you tell them?
Scott Terrio: Pause.
Doug Hoyes: Pause?
Scott Terrio: Yes, don’t do anything impulsively.Put the money in some kind of secure bank, preferably somewhere you don’t already owe money. Just keep the money safe somewhere in an institution and sit down and figure out what the best thing to do is. It isn’t rocket science; you don’t have to be a financial expert to make a good move, but be careful what you read and where you read it. Talk to somebody who is in the industry, if you can.
If you have debts I would advise you to speak to a trustee; it’s free. I mean we’re going to sit down and do just what you and I just did. We do this every day. Okay, what do you have, what do you own, what do you owe? What’s your situation? Is the government after you for taxes, whatever, right? And so you’re going to get advice, for free, on what the best move you can make is, because once you make certain moves you can’t undo them. And that is the fear, is that people go down a road they didn’t know that they shouldn’t do that, and then you’ve already put yourself in a pickle and essentially you’ve blown that money to a certain extent. So, pause, you know, talk to somebody that knows what they’re talking about, don’t do anything at first.
Doug Hoyes: Excellent. I think that’s a great way to end it. Scott, thanks for being here.
Scott Terrio: Thank you, Doug.
Doug Hoyes: And I totally agree, there’s nothing worse than someone who comes in and says, yeah, I’ve $10,000 a few months ago and I paid off that one thing, but now these other guys are after me. It’s like, oh boy, if you’d come in a few months ago we probably could have used that for everybody.
Scott Terrio: And one thing that everyone you and I have ever met with has said is that I should have come in here 12 months ago,or something, because then those things would not have happened.
Doug Hoyes: Yeah, it’s easier, like you say,to fix something before you’ve actually done it.
Excellent. Well, thanks very much, Scott. That’s our show for today. A full transcript and links to everything we talked about and how you can contact Scott here can be found in the show notes over at Hoyes dot com, that’s H-o-y-e-s dot com.
Thanks for listening. Until next week, I’m Doug Hoyes, and that was Debt Free in 30.