There’s No Easy Answer

When your vehicle’s odometer sneaks closer to the “No Warranty” number, how do you feel?    For me, this is a race I don’t like winning.  I know when the number changes to 100,000 kilometers (or 60,000 miles), time’s up.  Any repair costs will now be at our expense unless we have opted for extended warranty.

When I think the repairs are about to happen, they generally do.  Not minor repairs, but costly ones. One month it’s $1,000; the following month $500. Even though regular oil changes and service checks have been done, breakdowns are destined to occur.  

Purchasing, maintaining, and repairing vehicles are major expenses for owners.  In addition there are the registration fees, insurance, fuel and oil costs. To get from Point A to Point B, when there are no other options for transportation, our vehicles become a necessity, not a luxury item.   Our challenge is to ensure we budget for the costs associated with driving and replacing them.  This is literally where the rubber meets the road. 

The basic questions are:

• What can we afford to drive? 

• What is a practical vehicle to drive for our needs?   

Many conversations have been had with family and friends about the search for “the one” that answers our basic questions.  The concern which always surfaces is “Are we making the right decision?” Taking our time is better than rushing through the buying process. There’s nothing worse than a wrong choice. You can’t turn back the clock expecting the dealership to refund your money when you return the vehicle.  I know someone who tried.  The mistake was costly. Doing your homework is important.   Sleep on your decision more than one night.  Take as long as you like until you are comfortable with your pending purchase. 

Here’s a “Are-You-Sure-This-Is-The-Right-One” checklist:

q Whether your vehicle is driven for personal or business purposes, consider how many kilometers (or miles) you drive each year.  This information provides a clear indication of the length of time the warranty will cover major repairs. This is also key in determining the number of years you will own this vehicle before it will be replaced.  Kilometers are more speedily accumulated when you live in rural areas.  Medical appointments, entertainment events, and shopping trips to the city can rack up kilometres quickly in a year.  Knowing your annual mileage will provide information for the following points. 

q When a vehicle is used to earn business income, Canada Revenue Agency (CRA) allows any related expenses to be deducted as an eligible business expense.  Maintenance expenses, tire replacement, registration, insurance costs, loan interest, and depreciation reduce your taxable business income.  In turn, these costs can reduce your overall tax bill.  When a vehicle is used for both business and personal purposes, the expenses are pro-rated based on the number of kilometers driven only for business.

q Be cautious about believing that a loan financed at 0% is great deal.  For your benefit, ask for two comparisons:  one if you were financing the vehicle at 0% and the other, if you were financing at a low interest rate.   You might be forfeiting a price discount on the purchase when you choose 0%.  Investigating and evaluating your options is the best way to be certain you’re getting the best deal.

q When financing is required, always work the new payment into your budget before leaping into a vehicle purchase. Without crunching the numbers, you are only assuming you can afford the bi-weekly payments. Knowing for certain is better than assuming.  Then take the next step. Include the cost of the registration and insurance so you are not surprised by these expenses. A severe change in any costs can be a disaster to your spending plan.

q If you are looking for a different vehicle but are hesitant to pay the “new price”, you might consider an upgrade to a newer model with reduced miles and remaining warranty.  A slightly-used “new vehicle” rather than a “brand-new” one has a trimmed-down price.  Another option may be to snatch up a new vehicle at a reduced price late in the year when the next year’s models are available and the dealers want to get rid of their existing inventory. 

q “Own a newer vehicle” may be only one thing on your long list of goals and dreams. Before you determine the make and model of your new purchase, pre-plan the amount you are willing to spend.  In Suze Orman’s book, The Courage to Be Rich, she makes a valid point, “…it’s certainly a component of our collective consumer machismo: You are what you drive, for as long as your drive it.  Cars are our ultimate symbol of success, and they display the level of success we’ve achieved ~~ or the level of success we want others to think we’ve achieved:  This is who I am, because this is the make and model I drive…I am asking you here not to let what you drive today drive your destiny tomorrow.”  I believe her point is well-made.  Look at your dream list and do the math. Putting all your money into the new purchase at the expense of your other dreams might be less than ideal.     

      

q Where we live certainly plays a part in deciding what we drive. Living in rural areas, you may factor your road conditions for all the seasons.  Are the roads and highways passable if you need to travel in the winter months?  A SUV (Sport Utility Vehicle) may not be seen as a luxury but rather a necessity. Health and mobility reasons may factor into your decision. It’s essential that you find a vehicle to meet both your needs and budget.

q There’s a fine line between a dealership wanting your trade and not caring whether you trade.  Simply said, your vehicle might not be worth as much as you think it is because it is either too old, has too many kilometers, or both.  An older vehicle with more mileage equals less trade value. Certain makes and models depreciate more rapidly than others.  Being conscious of the fine line is worth noting on your next purchase.  If you are not sure, you may ask a salesperson who knows.    

q To trade (or not trade) your present vehicle towards the new purchase should be examined.   The value of the trade reduces the amount of GST (Goods and Services Tax) and PST (Provincial Sales Taxes) added into the final sale price.  When you have an opportunity to sell yours privately and receive a higher value than the dealership is offering for a trade, then this is a better option, especially if you can also recoup the taxes from the sale.

   

q If you are financing your purchase and are looking for ways to reduce your payments, consider putting some cash into the deal. Doing so will keep your loan payments in line with your budget.  If the extra cash means stripping your emergency savings, then this is not advisable.  Ensure all the pieces of the puzzle fit your purchase.

  

q When choosing the amortization period for your loan, pick a term equal to the length of time you plan to own the vehicle.   The plan is to ensure when you are ready to sell or trade that the loan is paid in full.  By doing so, you avoid consolidating the remaining loan balance with a new one.  Continually trading and purchasing vehicles over a period time will compound into a problem whereby the loan balance will be higher than its value.

q If you are certain you will purchase another vehicle in your lifetime, the best strategy is to save for it.  For most people, this request seems impossible because their budget may be tight already. However, when you know the purchase is likely to occur, being realistic and planning is better than doing nothing.  Saving some money while financing the balance is an appropriate strategy. Loan payments are usually looked upon as “forced savings”.  People are more committed to making a loan payment than actually setting money aside in advance towards their purchase.  However, extreme caution will need to be implemented as one approaches retirement.  Managing loan payments on a fixed retirement income may be challenging. 

q Make time for comparison shopping.  Whether you conduct your shopping online, in person, or by phone, you are collecting information to help with the final decision.  Because you are investing a large sum of money into a vehicle, you should look at this as an investment.  Falling in love with the first one you see and leaping ahead with the purchase could be a potential mistake. You don’t want any regrets.      

Above is my Baker’s Dozen, thirteen points to help answer the “Are-You-Sure” question.  I personally am not a fan of vehicle shopping because the analysis seems to take the fun out of the experience.  However, the analysis is the important stuff which ensures you have made the right decision.  You will appreciate your purchase more if you don’t have to live with any regrets. The secret is to strike a balance between the analysis and the experience. Create an adventure for yourself. You are hunting for a treasure you’ll appreciate.  Be patient with the search. Sooner than you realize, your hands will on the steering wheel of your ideal dream.   

Line of Credit – The Upside and Downside

 

Have you ever tried something only to discover later that it wasn’t suitable for you? Imagine a relaxing game of golf, a sweater fashioned in trendy colours, or mouthwatering, savory lobster. You may not feel the same about certain activities or things as your friend.   There is truth in Paul Alessi’s words. “There are two sides to every story.”

Depending on the story, situation, or product, you are likely to lean heavily one way or the other. You either like it or you don’t.  You prefer the upside and don’t see any downside. If you are optimistic, you see only the bright side and avoid the dark side.   

Such is the case with the various loan products on the market.  Loans have two stories, advantages and disadvantages. Different loan products are created specifically for different needs.  The features and benefits of a Line of Credit (otherwise known as a revolving loan) are designed to accommodate unique circumstances.  

 

THE UPSIDE

A “Line of Credit” is different from your traditional loan in such a way that you can access “borrowed cash” at any time for any purpose.  Like a credit card, a specific limit is assigned with a Line of Credit, allowing you to draw down to the limit.

These loan products are becoming incredibly popular. Having a Line of Credit is convenient for you and your loan officer.  Instead of running to the bank every time you need a loan, you make an application only once for a Line of Credit.

One major benefit is the interest is calculated daily only on the outstanding balance. You are only charged interest on the amount of money used. If you dip into your Line of Credit two days prior to payday, then interest is charged only for those days. Generally, the interest rate with a Line of Credit is lower than any credit card, saving you money on interest charges.   

Another benefit most people appreciate is that, unlike a credit card, you are not required to make specific payments monthly.  The monthly interest charges are billed against your available balance. However, the expectation is that deposits are made regularly to ensure the account revolves and is used appropriately.   

This pool of readily available cash can be accessed for any purpose at any time. When emergencies occur, you may suddenly find yourself in a pinch. It’s an acceptable practice to use someone else’s cash to pull you through a rough spot.  The question to ask yourself is whether you can become too dependent on a Line of Credit.  Even with a lower interest rate, the interest costs on a Line of Credit add up to a significant amount over an extended period of time. You may discover you are regularly touching the bottom on your limit.



Bank Statement - Line of Credit

 

THE DOWNSIDE

Lines of Credit can certainly be a security blanket when your emergency savings are inadequate to cover your present situation.  

The upside obviously spoke about convenience. We live in a world where “instant results” have become an expectation. Having access to credit for expenses or purchases is a privilege.  We shouldn’t take advantage of credit for every desire because one day we may find ourselves in financial trouble when we have overextended the boundaries.  The blog, Choosing Your Debt Wisely, proves how debt can quickly become out of control.      

As previously mentioned, one attraction of a Line of Credit (LOC) is the interest rate. Compared to a credit card or payday loan, the Line of Credit interest rate is lower than these two.  Take another step and secure your Line of Credit with property. The interest rate is reduced further simply because your promise to pay back the money is pledged by an asset, something you own.  The security can either be your home, vehicle, or investments.  You declare, “I solemnly swear to pay back every penny, and if I don’t, you may take my house, car, boat, and my children.” (I’m kidding about the children.)  Don’t overlook the risk you are taking when you pledge security.

The downside to becoming too dependent on Lines of Credit is that we never see the light, the bright side of being debt free forever.  Lines of Credit are loans.  Borrowed money eventually has to be paid back. As long as we are working and have the means to pay back borrowed money, everything rolls along until the income stops.  Job layoffs, sudden illnesses, and disabilities can interrupt a steady income. The inability to pay back the Line of Credit can suddenly mean financial devastation. 

Be wary of the convenience and low interest rate that a Line of Credit claims to offer.  It’s true that interest is calculated daily only on the amount you use; however, the financial damage occurs when you compromise security for convenience.  This loan product disguises borrowing money for purchases with a convincing argument that a Line of Credit saves you money.   Home equity loans allow the equity in your home to be used for other purposes: debt consolidation, home renovations, investment opportunities, and vehicle purchases.   The intent with this type of loan product is to simplify your life by combining your income and debt under one roof (one account).  You may be convinced the true intent is to lower your borrowing costs.  That’s a good point but you must know and trust yourself. Although this loan product and strategy may work for someone, it’s not necessarily the right product for everyone. Your responsibility is to fully understand the product and match the right one to your needs.

 

THE BRIGHT SIDE

Remember we know our spending habits.  Sometimes, we have a tendency to believe that if we have money available on our Line of Credit, we have cash but these are two different animals. Credit is not cash.

When I had a Line of Credit attached to my chequing account, I constantly did the math.  I calculated how much I could spend before I hit the limit.  That kind of wrong thinking left me frustrated. I finally recognized the craziness in my logic.  If my account was into my $1,000 Line of Credit by $956.55, I believed I had $43.45 in my account.  Seriously? I was in debt $956.55.  Nothing could change the math. For me, the worst part was seeing a negative balance all the time.  I always felt broke.   Then, I opted to replace my Line of Credit with a revolving loan product separate from my chequing account.  I preferred regular payments which ensured my loan would be eventually paid.  The best part was seeing the positive balance in my chequing account, even if it was only $1.

If you are disciplined, then you have no worries.  If you’re not disciplined and are madly in love with the Line of Credit product, I often recommended attaching the credit limit to a separate account, apart from your active chequing account.  Then you can apply consistent payments to the outstanding loan balance with the intention of eventually paying off the debt.

The secret is in knowing whether you can trust yourself with the freedom to have an endless amount of credit (not cash).  Your responsibility is to learn and understand the different loan products. With the right advice, you can match the right one to your needs.  Managing your debt responsibly is one sure way to live a worry-free lifestyle.

Borrowing Money Is Like Jumping Hurdles

 

 

Imagine yourself seated across the desk from a loans officer, waiting anxiously to hear the verdict.  Will your request for a loan be approved?  Initially, you felt confident and now you have doubts.  What exactly is the loan officer analyzing?

The credit process can be likened to jumping over hurdles.  As you jump through the following points, you get a sense of the criteria the loans officer puts under the microscope to analyze whether you qualify.  

Hurdle #1: Your Credit Report.  Your credit report will be your first means of defense.  If you have always consciously made your payments in a timely manner, meeting all your loan obligations, then you should have no concerns.  Quite often, people don’t realize what’s involved in maintaining a healthy credit report.  To ensure you understand your credit report and credit score, click here for additional information from Financial Consumer Agency of Canada.  If your credit score is low, you can improve this by implementing some sound strategies as shared in the previous blog, Protect your Score.

Hurdle #2.  Capacity to Make Payments. You can be assured your income plays a significant factor in determining whether or not your loan is approved. Capacity is measured by using ratios: Gross Debt Servicing (GDS) and Total Debt Servicing (TDS).  These are math calculations to ensure your debt payments don’t interfere with your ability to manage day-to-day living expenses.   

GDS focuses on your ability to meet shelter costs, rent or mortgage payments.  That’s all it does.  Generally, when applying for a mortgage, this ratio is used to measure your ability to manage payments.  The amounts factored into the calculation are: mortgage payment (including principal and interest), property taxes, and heating costs.  If the mortgage is for the purchase of a condo, then 50% of the condominium fees are also included.  Once these amounts are tallied, the total is divided by your gross income and then multiplied by 100 to determine your ratio.  Keep your fingers crossed! The guidelines are 25% to 30% of gross income. (Sometimes 32% is acceptable.) The lower the ratio the better since this indicator measures the percentage of your gross income required to cover shelter payment.  For example, if your ratio is 15%, then only 15% of your total gross income is funding your mortgage/rent payments. 

The formula for calculating GDS is as follows (calculate either monthly or annually):

 

Payment of principal and interest on mortgage                                              + property taxes                                              + heating costs                                              + 50% of condominium fees (if applicable) GDSR =                    -----------------------------------------------------------------------------                                              Gross Income

 

TDS calculates your ability to manage all debt obligations including child and spousal support payments.  For many, the big surprise is the payment amount for credit cards is calculated on the available credit limit, not the outstanding balance.  You may have an outstanding balance of $5,000 but your MasterCard credit limit is $15,000.  Your payment used in the calculations will be $450 (3% of $15,000) since you have access to this credit at any given time.   Because you haven’t used the entire balance today, doesn’t mean you won’t tomorrow.  So lenders realize that if you do, then monthly minimal payments will increase.  Although having access to a high credit limit may be beneficial, the full payment affects your TDS ratio as well as the credit limit is the amount shown as a liability on your Net Worth Statement.  

Since you are aware of the amounts involved in the TDS calculation, tally the total, divide by your gross income, and multiply by 100 to determine the ratio.  Ideally your TDS should be 35% or less.  Some institutions allow a ratio of 40%.  Although your loan may be approved despite your high ratio, you have to consider the financial situation in which you may place yourself.

Here’s a glance at the formula for calculating TDS (calculate either monthly or annually):

 

Payment of principal and interest on mortgage                                              + property taxes                                              + heating costs                                              + 50% of condominium fees (if applicable)                                              + payments on other personal loans TDSR =                   -----------------------------------------------------------------------------                                              Gross Income

 

Hurdle #3: Your Net Worth (Capital).  Another measurement of creditworthiness is your present net worth. When assigning a value to assets such as motor vehicles, snow machines and the like, use realistic values. Do not overvalue them. Vehicles are a perfect example since they quickly depreciate. In reality, question whether someone would be willing to pay this amount for a particular asset. 

To help create your Net Worth Statement, click here to use this on-line calculator. Once your statement is created, liabilities are subtracted from assets. If your liabilities are greater, then your negative net worth is alerting your loans officer to a potential problem.  Generally, the one exception for showing a negative net worth is if a student acquires debt in pursuit of an education. Technically, as a student, you are an asset with the ability to generate an income to pay off your student loans. 

 

Assets Everything You Own	Liabilities Everything You Owe
Net Worth (Assets – Liabilities)

 

 

Hurdle #4: You (and Your Character).  It’s about you.  Attitude is everything.  Attitude shows up in your credit report, your ability to be employed, and in your conversation with your loans officer.   The important question to answer is: Will you uphold your promise to repay the loan? As time goes on, you accumulate a history which will follow you.  Establishing a strong relationship with your loans officer will be important.  Over time, you, no doubt, may require more than just one loan. 

 

Hurdle #5:  Collateral.   The reasoning behind using collateral to secure a loan is assurance that some or all of the money can be retrieved if you happen to default on your loan.  So many unforeseen events might occur to cause you to miss payments and neglect your financial obligations. Eventually, the only recourse remaining for the lender is to sell your asset to repay the loan.  Whether you assign your car, investments, or house, as collateral, you pledge a promise to pay back the debt. In the event you don’t, then the asset will no longer be yours.  When examining all the criteria to approve your loan, collateral generally would be the last consideration.

 

How does everything look as you jumped over the hurdles?  This information cracked open the door to the credit assessment process. Everyone’s borrowing needs are different; special consideration is given to special circumstances.  Guidelines are in place as tools to help with the process.  Not only are the financial reports and ratios analyzed but your loans officer also implements good judgment on your behalf.  When you continue to meet your loan obligations consistently over time, you will build both a trusting relationship with your lender and a strong credit history.  This best outcome when borrowing money becomes necessary to fulfill your dreams.