Having been in this industry for quite some time and meeting quite a lot of clients it still surprises me how poorly some clients manage their personal finances. I can’t blame some of these clients though. I don’t think our society does a significant job in educating individuals about personal finance especially at the school level, where most curriculums don’t incorporate this very important and necessary life skill.
The reality is that many clients aren’t aware of the options available to them to help put them in a better position or aren’t making the effort to speak to someone who can review these options.
Here’s a typical scenario:
-John and Anne Smith are in their early 40’s with two children. They are earning a comfortable combined income of $140,000 but are having difficulties meeting their cash flow requirements every month with all the children’s activities and are having a hard time saving for their retirement. They also have some credit card balances that they’ve been carrying on higher interest credit cards that they can’t seem to payoff along with a balance on their line of credit (LOC) for a recent used car purchase.
Here are the numbers:
Combined Income: $140,000
Home Value: $550,000
Mortgage Balance: $250,000 (3.50% 5yr fixed rate, 20 yr amortization); $1,500/mth
Retailer Credit Card: $3,000 (19.99%); $100/mth
Electronics Retailer Credit Card: $2,000 (29.99%); $100/mth
Bank Credit Card: $6,000 (10%); $120/mth
LOC: $18,000 (6%); $200/mth
Total credit balances (excluding mortgage): $29,000
Total credit balances including mortgage: $279,000
Total monthly payments to service all credit accounts: $2,020
Total annual interest cost: $11,120
On top of all their other living expenses (food, car etc) they are currently paying $2,020 to service all their credit products along with incurring an interest cost of $11,120 over 12 months.
Is there a better option for them? Yes! In this scenario one very attractive option would be a refinance. Essentially, they would borrow against the equity in their home to help cover all these higher interest balances.
Their home is valued at $550,000. Most lenders will allow you to borrow up to 80% of your property value. In this example 80% would be $440,000, more than enough to cover all their debt.
Here’s a revised version of their numbers after the refinance:
New refinanced balance to cover all credit balances: $279,000
New mortgage at 3.50%, 20 year amortization: $1,615/month
Total annual interest: $9,539
Monthly cash savings: $405 ($2,020 – $1,615)
Annual Interest savings: $1,581 ($11,120 - $9,539)
By consolidating all their credit balances the Smiths have been able to free up $405 every month, saved over $1,500 in the first year and only have to worry about one payment!
With the freed up $405, the Smiths can contribute toward an investment account (RRSP, TFSA etc) to help save for their retirement, use the excess cash to help manage their cashflow or ideally they can use a portion of this savings to prepay their mortgage. By making an additional $200/month the Smiths can actually shave 3 years off their amortization down to 17 years (from 20), helping them save even more ($12,990 over 5 years!).
Don’t let the numbers overwhelm you in this case. I think what’s important to note is that there are options available to help strengthen your financial position. Aligning yourself with a professional that you trust to review your options, would be the first step in becoming more financially better off.