Being smart with debt earns top marks
Borrowing money and using credit are important – and for most of us, necessary – ways to achieve your financial or lifestyle goals. Whether you're buying a home or car, or renovating a kitchen, a trip to a lender is likely in the cards.
However, how you manage debt can make a big difference to both your bottom line and your peace of mind. Fortunately there are some simple steps you can take to save interest and be free of debt years sooner.
Get more from your mortgage
When it comes to saving money on your mortgage, finding a competitive interest rate is an important start, but it's not all you can do. Mortgages have interest-saving features such as prepayment options that let you pay off your balance years sooner, saving you thousands of dollars in the process. Here are the most common options that you can take advantage of.
Increase the frequency of your mortgage payments. Making more payments will noticeably shorten your payback period and reduce the amount of interest paid. Here's an example of how much you can pocket by switching from paying monthly to bi-weekly (every two weeks).Figures are rounded for illustrative purposes.
|Years to Repay||21 years||25 years|
|Total Interest Paid||$74,460||$91,940|
If you also receive your pay bi-weekly, putting your mortgage payments on the same schedule is a convenient choice.
Increase your payment amount. By bumping up the size of your payment whenever you can (depending on your mortgage arrangement), you'll save in interest paid. The extra funds are applied directly to your mortgage principal, reducing what you owe and allowing your mortgage to be paid off years earlier.
Make anniversary payments. On each mortgage anniversary date you can typically repay a percentage of your original mortgage principal. These extra payments, usually between 10% and 20% of the principal, will shrink your mortgage balance faster. If you're expecting a tax refund from this year's RRSP contribution, consider using these funds to make your anniversary payment.
Refinance or "blend and extend"? If you're in a longer-term, fixed rate mortgage taken out when rates were higher, it's tempting to consider refinancing to take advantage of the lower rates available on variable rate mortgages. But while the interest savings may be enticing, you'll be subject to early payment penalties, which can be substantial. You need to consider how much time is left on your mortgage term and the difference in the interest rate. Your financial advisor can help you with the calculations to determine if the refinancing move will actually save you money.
An alternative offered by some financial institutions is to "blend and extend" your mortgage. Here, you average your existing rate with a lower one currently in the market, creating a new extended term at a blended rate. If you believe interest rates are on the way up, this route can be a way of securing a lower rate before your mortgage term renews.
Variable or fixed? If you do decide to refinance, this is an important question to consider. As global economies have slid into recession over the last year, the Bank of Canada, along with other national banks, has cut its overnight lending rate by a whopping 4% in an effort to bolster demand. The resulting historically low interest rates – reflected in the reductions to the prime rate set by financial institutions – can make variable rate borrowing options very attractive.
At the same time, fixed-rate mortgages are also a better deal right now than they've been in decades. Fixed-rate mortgages are based on bond yields which are market-driven and largely independent of the central bank moves.
So, which option is right for you? If you need predictable payments and an assured rate, you'll likely lean towards a fixed-rate mortgage. But if you can live with a little more uncertainty, you could potentially save more money with a variable rate mortgage. This is where a talk with your financial advisor can be a big help.
Leverage home equity for lines of credit
Despite the recent correction in the real estate market, if you've been a long-time homeowner in B.C. you've built up a significant amount of equity over the years. Home equity is the key to paying lower - perhaps much lower - interest on credit. One option is to establish a home equity line of credit. Because this line of credit is secured by your home, you become eligible for your financial institution's best rate. With a home equity line of credit you can consolidate higher-rate obligations into a single, low-rate balance. This is an important advantage if you're paying higher interest on personal loans and credit cards, (particularly store cards which feature rates as high as 28%).
With a home equity line of credit you have the convenience of making one monthly payment instead of several, while saving interest. Once established, your home equity line of credit can be drawn on as needed for everything from home renovations to investments, without the need to reapply each time.
Better your credit profile
It pays to know your credit score and what's in your credit report even if your credit history is blemish-free. A strong credit rating can pay off in lower borrowing rates.
Your credit score indicates how 'risky' you are to lenders. The higher your score, the lower your risk profile. A favourable credit score gives you more flexibility to borrow at better rates, even in a tough economy.
Your credit report is available free of charge from the major credit reporting agencies operating in Canada: Equifax, TransUnion and Experian. This document details your credit history and is one of the key pieces of information used by lenders when reviewing your application.
Because the credit reporting agencies don't necessarily capture identical information, the best practice is to request your report from each. Doing so annually will help you keep your credit information accurate. Errors not corrected can negatively affect your credit profile. Regular reviews can also help protect you from identity theft by alerting you to unusual credit inquiries or suspicious credit applications.
So how can you raise a low credit score, even if you feel you manage your debt responsibly?
- Keep your number of loan and credit accounts to a minimum. Having too much spending capacity, or looking for credit too often, can raise concerns about your ability to pay it back.
- Don't stray too close to your borrowing limit. Experts recommend keeping your balances at least 35% below your available credit limits.
- Use your credit cards regularly and keep your account current. Building up a solid history of on-time payments will help demonstrate your creditworthiness to lenders. It's a simple way to build and maintain healthy credit.
For more information on these and other ways to get smarter with your debt, contact your BlueShore Financial financial advisor.