Blog Layout

How (Not) to Consolidate Debt

Diane Buchanan • Mar 02, 2017

By Sandi Martin of Spring Personal Finance.

The point: it doesn’t matter what method you use to pay off debt, or if you use any method at all. What matters is that you stop creating new debt.

It’s out there: the mathematically precise, strictly rational formula for paying off your three credit cards, small car loan, and fluid line of credit balance. It’s not too hard to calculate the most efficient way to allocate every dollar and wring the most interest-busting bang out of each buck.

If that doesn’t work for you – and let’s be honest, it often doesn’t  – there’s a psychologically motivating method that throws math out the window and concentrates on tickling your brainpan with the momentum of every dollar that’s paid off – like the eponymous snowball rolling down a hill.

Proponents of these two camps are territorial and permanently at odds. (I’m just spitballing here, but I imagine it has to do with not being able to live inside somebody else’s brain and see how it works, like so many other disputes.)

Frankly, I don’t care how you pay off debt, so long as you simultaneously stop creating more.

Enter debt consolidation. Often a polarizing bone of contention between the two camps, debt consolidation – for those three of you in the back of the room unfamiliar with the concept – is when a lender gives you the money to pay back all of your other debt that’s scattered across the country and pay them back instead. They win by getting a new loan on the books, and stealing market share from the competition. You win by bringing down your overall interest rate.

What’s to argue with, right?

This is what to argue with: there’s a teeny-tiny window of opportunity in which debt consolidation is a powerful tool to bring your debt-free date closer and eat vast chunks out of the total amount of interest you’ll pay. That window of opportunity is open for about half an hour, and when it closes, it’s so hard to reopen that it might as well be painted shut.

If from the outset you don’t commit to a payment that is equal to or more than the amount you were paying on your unconsolidated debt, and that will get your three credit cards, small car loan, and fluid line of credit paid off in less time than they were originally amortized for, then you’re not paying down your debt, you’re just moving it around.

If you don’t take a long, hard look at how you got into debt in the first place, and – from minute one of your newly consolidated life – take measured, calculated steps to not do it again, those credit card balances are going to creep back up again. You’ll find yourself in the same office, maybe even in front of the same banker, signing a new set of loan papers for a new consolidation loan three years down the road.

I began my career in banking in the heyday of debt consolidation lending. The amount of new unsecured dollars added to our lending portfolio was a huge component of our sales scorecard, and while the focus shifted to include a wider spectrum of  product sales after 2008, banks are still hungry for your debt consolidation dollars. *

Folks, I’ve seen a lot of debt consolidation train wrecks, and about five of them where due to circumstances beyond the borrower’s control. The other 7,256,219 were due to the window slamming shut, either because the borrower didn’t know or didn’t care about it.

I’d love to blame the bank for it (you know I would), but I can’t. Yes, the banker you sit across from has incentive to talk you into stupid stuff that’ll not only shut the window of opportunity, but nail it closed and board it up too. (“Increasing your cash flow” is a phrase that comes to mind.)

But down in the land of brass tacks, you just signed a loan to pay off other loans. If you weren’t thinking about how you got to this point at this point, when else are you going to think about it?

If it was important enough to you to take action, why isn’t it important enough to change your behaviour?

* They’d like those dollars to be in the form of a secured line of credit, though, and will sell you on the fact that you can consolidate again and again and again, without ever having to go back into the bank to do it.

This article was written by Sandi Martin of Spring Personal Finance and originally appeared on Spring the Blog here. 

DIANE BUCHANAN
 Mortgage Broker

LET'S TALK

Lowering Your Overall Cost of Borrowing

By Diane Buchanan • 01 May, 2024
If you’re like most Canadians, chances are you don’t have enough money in the bank to buy a property outright. So, you need a mortgage. When you’re ready, it would be a pleasure to help you assess and secure the best mortgage available. But until then, here’s some information on what to consider when selecting the best mortgage to lower your overall cost of borrowing. When getting a mortgage, the property you own is held as collateral and interest is charged on the money you’ve borrowed. Your mortgage will be paid back over a defined period of time, usually 25 years; this is called amortization. Your amortization is then broken into terms that outline the interest cost varying in length from 6 months to 10 years. From there, each mortgage will have a list of features that outline the terms of the mortgage. When assessing the suitability of a mortgage, your number one goal should be to keep your cost of borrowing as low as possible. And contrary to conventional wisdom, this doesn’t always mean choosing the mortgage with the lowest rate. It means thinking through your financial and life situation and choosing the mortgage that best suits your needs. Choosing a mortgage with a low rate is a part of lowering your borrowing costs, but it’s certainly not the only factor. There are many other factors to consider; here are a few of them: How long do you anticipate living in the property? This will help you decide on an appropriate term. Do you plan on moving for work, or do you need the flexibility to move in the future? This could help you decide if portability is important to you. What does the prepayment penalty look like if you have to break your term? This is probably the biggest factor in lowering your overall cost of borrowing. How is the lender’s interest rate differential calculated, what figures do they use? This is very tough to figure out on your own. Get help. What are the prepayment privileges? If you’d like to pay down your mortgage faster. How is the mortgage registered on the title? This could impact your ability to switch to another lender upon renewal without incurring new legal costs, or it could mean increased flexibility down the line. Should you consider a fixed rate, variable rate, HELOC, or a reverse mortgage? There are many different types of mortgages; each has its own pros and cons. What is the size of your downpayment? Coming up with more money down might lower (or eliminate) mortgage insurance premiums, saving you thousands of dollars. So again, while the interest rate is important, it’s certainly not the only consideration when assessing the suitability of a mortgage. Obviously, the conversation is so much more than just the lowest rate. The best advice is to work with an independent mortgage professional who has your best interest in mind and knows exactly how to keep your cost of borrowing as low as possible. You will often find that mortgages with the rock bottom, lowest rates, can have potential hidden costs built in to the mortgage terms that will cost you a lot of money down the road. Sure, a rate that is 0.10% lower could save you a few dollars a month in payments, but if the mortgage is restrictive, breaking the mortgage halfway through the term could cost you thousands or tens of thousands of dollars. Which obviously negates any interest saved in going with a lower rate. It would be a pleasure to walk you through the fine print of mortgage financing to ensure you can secure the best mortgage with the lowest overall cost of borrowing, given your financial and life situation. Please connect anytime!

Fixed-Rate or Variable-Rate Mortgage?

By Diane Buchanan • 24 Apr, 2024
If you're looking to buy a new property, refinance, or renew an existing mortgage, chances are, you're considering either a fixed or variable rate mortgage. Figuring out which one is the best is entirely up to you! So here's some information to help you along the way. Firstly, let's talk about the fixed-rate mortgage as this is most common and most heavily endorsed by the banks. With a fixed-rate mortgage, your interest rate is "fixed" for a certain term, anywhere from 6 months to 10 years, with the typical term being five years. If market rates fluctuate anytime after you sign on the dotted line, your mortgage rate won't change. You're a rock; your rate is set in stone. Typically a fixed-rate mortgage has a higher rate than a variable. Alternatively, a variable rate is not set in stone; instead, it fluctuates with the market. The variable rate is a component (either plus or minus) to the prime rate. So if the prime rate (set by the government and banks) is 2.45% and the current variable rate is Prime minus .45%, your effective rate would be 2%. If three months after you sign your mortgage documents, the prime rate goes up by .25%, your rate would then move to 2.25%. Typically, variable rates come with a five-year term, although some lenders allow you to go with a shorter term. At first glance, the fixed-rate mortgage seems to be the safe bet, while the variable-rate mortgage appears to be the wild card. However, this might not be the case. Here's the problem, what this doesn't account for is the fact that a fixed-rate mortgage and a variable-rate mortgage have two very different ways of calculating the penalty should you need to break your mortgage. If you decide to break your variable rate mortgage, regardless of how much you have left on your term, you will end up owing three months interest, which works out to roughly two to two and a half payments. Easy to calculate and not that bad. With a fixed-rate mortgage, you will pay the greater of either three months interest or what is called an interest rate differential (IRD) penalty. As every lender calculates their IRD penalty differently, and that calculation is based on market fluctuations, the contract rate at the time you signed your mortgage, the discount they provided you at that time, and the remaining time left on your term, there is no way to guess what that penalty will be. However, with that said, if you end up paying an IRD, it won't be pleasant. If you've ever heard horror stories of banks charging outrageous penalties to break a mortgage, this is an interest rate differential. It's not uncommon to see penalties of 10x the amount for a fixed-rate mortgage compared to a variable-rate mortgage or up to 4.5% of the outstanding mortgage balance. So here's a simple comparison. A fixed-rate mortgage has a higher initial payment than a variable-rate mortgage but remains stable throughout your term. The penalty for breaking a fixed-rate mortgage is unpredictable and can be upwards of 4.5% of the outstanding mortgage balance. A variable-rate mortgage has a lower initial payment than a fixed-rate mortgage but fluctuates with prime throughout your term. The penalty for breaking a variable-rate mortgage is predictable at 3 months interest which equals roughly two and a half payments. The goal of any mortgage should be to pay the least amount of money back to the lender. This is called lowering your overall cost of borrowing. While a fixed-rate mortgage provides you with a more stable payment, the variable rate does a better job of accommodating when "life happens." If you’ve got questions, connect anytime. It would be a pleasure to work through the options together.
Share by: