Tommy: Most homeowners know something about the home equity line of credit, while it might seem like a good idea, an easy way of getting extra cash for a remodel, unforeseen expenses, for a vacation, for a wedding all kinds of things but it will help you sink deeper into debt. And yes you actually have to pay it back. You can’t just borrow more and then pay that. Lump it in with other bills and you might find yourself overwhelmed with monthly obligations. My next guest has some definite opinions on how and why people use the home equity line of credit and she continues to help people get out of the financial hole. Welcome money coach, Lama Farran who now joins me. Good morning.
Lama: Good morning to you Tommy.
Tommy: What’s the reason most people take out a home equity line of credit?
Lama: First of all the bank pushes it, right you go to the bank and most of the time the person sitting behind the desk will advise you that a line of credit is going to be good for you, because it has a low interest rate, it’s between 3-4% it’s variable, but really it’s the lowest interest rate out there. So you think, oh that’s great. The other thing that they will tell you is it’s going to require minimal monthly payments,because it’s only the interest that you have to reimburse every single month. You’re looking at this, and of course you trust your bank and you trust their advice, and you think okay I want one of those. Usually people also take it because they don’t have an emergency fund. And it acts like an emergency fund. It makes you a bit lazy to work and have some savings because if something comes up, you think I have a line of credit to bail myself out.
Tommy: And also if there is anything out there that you want to buy, just buy it on the line of credit.
Lama: Exactly or if you’re lacking cash in your account, you log into your online account and you transfer from your line of credit to your bank account and suddenly you feel rich.
Tommy: That’s right and people forget that they eventually at some point it doesn’t have to be paid back.
Lama: Yes, they forget because the bank is not asking for it. They say, you know what when you feel like it and when you do, and if you do you can pay it back. If not don’t worry about it, just keep paying us in interest every month and you don’t have to worry about the principal. And we know that people lack financial discipline, and if no one is there forcing you to pay the principal, you never do.
Tommy: So what is an example you’ve seen of people who have used it properly and example of people who have abused the home equity line of credit.
Lama: Unfortunately I’ve seen more people abusing it than using it properly, but i’ll give you an example of using it properly. It could be used as a down payment for you to buy a rental property. If you want some extra income, but you’re not sure where the down payment is going to come from, you can use the equity in your existing home to buy a rental property. So, for investment purposes it could be something good. It’s not good when you go to, I don’t know, Bahamas in December and it’s comest you $60 000 a week, and you come back and think how do I pay for this thing, okay I’ll dump it on my home line of credit. So basically you’re mortgaging in your house to go on vacation, which is kind of scary when you think about it.
Tommy: So basically the banks don’t care, they’re getting the interest and since it is against your home, they are going to get their money back. They aren’t worried at all.
Lama: Not only do they not care but they want you to use it. It is a very profitable product for them because the principal is always there, you’re never paying it down so they are just getting their interest every single month, month after months. So they’re happy when you use it. They’re not happy with me who has it downto 0, because it doesn’t give them anything.
Tommy: Now what is the current rate of interest for a home equity line.
Lama: It’s usually, it’s variables, so it’s prime plus maybe half, or plus one max. So our prime is 3%, so you can get it for 3.5% or 4%. And we know prime hasn’t moved in four years almost so people aren’t really feeling the pinch of interest rates going up now, because it’s been stuck at 3 for the last few years.
Tommy: Is there a limit to how much somebody can borrow?
Lama: It’s 80% of your home value. So if you have a $500 000 you can go get up to $400 000
Tommy: That’s without, that’s if you don’t have a mortgage.
Lama: Yeah, that’s right.
Tommy: If you have any questions, Lama Farran my guest. What advice do you have for people who have made that mistake and they are looking at their home q=equity line of credit and it’s very very high.
Lama: First of all you have to start facing your situation. You have to get your head out of the sand, and look at where you money is going every single month and how are you going to find the extra money to pay it off, even if it’s going to take you 15 years or 20 years, whatever it is just have a plan of how much am I willing to put down on the principal every month. Whether its $200 or $500, whatever gfits in your budget.
Tommy: When people come to you for help, what’s your most common problem?
Lama: Debt, definately debt. Debts and the major thing is I don’t know where my money is going. It’s this big mystery of my paycheck comes in and I don’t know what happens to it.
Tommy: How do you help them solve that problem?
Lama: First of all it’s the tracking. Teaching is really important. Until you put down in writing where every dollar is going,you’re still not going to know where your money is going. Everybody knows that they have a certain month mortgage, their cell phone, their insurance, all the other amounts are very nclear in people’s heads. Tracking is the number one tool to start putting some clarity into your situation.
Tommy: Do people underestimate how much you’re spending if they are not doing this tracking.
Lama: Yes they do. And once I do the exercise with them and they look at the deficit at the end of the month, they’re like oh my god. That’’s why I have to dip into my line of credit every month. But when they see it black and white, I’m in the red for thousand dollars every month or $500, then we can work backwards and say what are we willing to cut down and where in order to bring the deficit to 0 or to hopefully a surplus.
Tommy: This texter wants to know, we are about to endeavor trying a small house expansion renovation, our mortgage is up for renewal in August. We are thinking of adding $70 000 to our mortgage through refinance. The bank is trying to convince us to use a home equity line of credit. I wasn’t looking for two places to pay. Any thoughts? I hate multiple areas of debt.
Lama: Well, are the renovations really essential? Does she really have to go up to $70 000, or is just because the bank is telling you that you have the possibility of getting that much? And second reason, if it is necessary, what is your plan to pay down the $70 000. The bank is not going to ask you to pay down the principal, how are you going to fit it in your budget to pay that $70 000, and what’s the deadline that you’re giving yourself to pay it back?
Tommy: You know when we expand this discussion to the economy, people are living not on the money that they earn, their living on borrowed money.
Lama: Exactly. Statistics Canada came up with the figure last year and they said for every $100 that Canadians make, they had $163 of debt. Basically we are forever spinning our wheels because you income is only $100 and you’re spending $163.
Tommy: And I guess people are also depending on the price of real estate to continue going higher forever. They’ll always go higher and higher. So that they think that they will be able to pay off this home equity line of credit and still have money left over.
Lama: Well if you keep increasing your home line of credit as your house goes up and use it, you’re not going to have much left in the end.
Tommy: There’s a lot of texts coming in, we’ll get to as many as we can. My guest is Lama Farran, and she is a money coach. Her website maxworth.ca.
My guest is a money coach, Lama Farran. What exactly does a money coach do?
Lama: Well I don’t, the main difference between what I d o and a financial planner does is I don’t sell any actual products. So when I sit down with my clients, i look at their spending habits, we work out a budget, we see what’s the state of their debt, how can we set up a plan to get out of debt and I work in general how to improve their money managing skills. It’s really about their behaviours more than me sitting down and advising you about products. I don’t do products.
Tommy: This texter wants to know, isn t a good idea to borrow the line of credit money to put into an RRSP?
Lama: It’s called leverage investments. Now there are RRSP’s with a level of risk aversion that he might be okay with, and another person might now sleep at night because of that.
Tommy: This one says, what if I borrow 80% against my house and invested all of that in Mutual Funds at 5%, and the amount of money I make offsets the interest from the 80% loan and I’m still profiting. So essentially I’m in eternal debt, but profiting every year until it’s time for me to pay it off.
Lama: Well that’s similar to the question before, it’s leverage investments. Borrowing to invest. Nothing guarantees that 5%, we saw in 2008 things went down 10-20%. So his 5% is a possibility, but there is also the possibility of having minus 5%.
Tommy: This one says, this texter is 36 years old, he writes, I’m 36 years old and have a home equity line of credit. I was thinking of borrowing on it to invest heavily in mutual funds for the ext five years. Say, $1000 a month. Your thoughts.
Lama: Same thing as the other ones. It’s, the mutual fund us not guaranteed, right. So are you okay with you mutual fund going down, and on one hand you’re paying interest on that loan.
Tommy: He’s not doing it for the whole house, this is $1000 a month.
Lama: We’re talking if the market crashes, you lose your investments and the house.
Tommy: Right but in this case he’s only losing, well some of it.
Lama: $1000 a month.It also depens on his income.
Tommy: There’s not much chance of a mutual fund going from $1000 to 0.
Lama: No, that’s right. But hey there’s a risk. Leverage investments is a topic on its own, really it’s how you deal with risk. I don’t deal well with risk, I’m not a risk person.
Tommy: Peter on the line, good morning.
Tommy: Yes, what’s your question.
Peter: Well, in reference to what your guest saying that people don’t know where their money went. I use my debit card with the Bank of Montreal, and I probably pay with 95% of the time. And on their website you can find a list of everything that I have spent, so I know exactly where my money goes. And of course the key is don’t spend money that you don’t have.
Tommy: Thank you very much for the call. So that’s very good, it’s money that you have it’s not on credit, it’s coming from your bank account and you have the list of exactly where you spend it.
Lama: I don’t know what he’s referring to, is he for example adding up all his transactions from the groceries. Is he adding up all the transactions from Tim Horton’s.
Tommy: Well he pays everything with his debit card.
Lama: Yes, I understand, but if I ask him how much you pay in coffees every month, does he know. If he’s able to add them up in a way, then he tells me yeah I know I spend $100 on coffee every month, and then I ask him if he’s okay with it. Right, is there any changing to the behaviour that we can do.
Tommy: Okay, this is very interesting. He says would you consider investing in the banks at 5% to be a risk. Because the way I look at it it, if the banks were ever to fail I would have a lot more problems than just the 80% against my house that I borrowed to invest.
Lama: Well, the truth is a lot of Mutual funds that you buy,a big big chunk of it is invested in the nig ank. They are very good investments to make, they make money. And every single quarter they break their records, quarter after quarter, so yes, banks are very good investments to make unfortunately.
Tommy: You’re going to like this one, this texter says Society tells us to spend money that we don’t have to impress people we don’t like.
Tommy: Very true. Your questions for our money coach, Lama Farran her website maxworth.ca, text your questions to 514-800. My guest is Lama Farran, she is a money coach. Her website maxworth.ca. Have you encountered situations where somebody is trying to put their money in their savings, maybe they put their money in Tangerine and they are getting their monthly 3% until the end of July, 2.5%. They are very happy about the fact that they are saving money. In the mean while they have 3 or 4000 saved, and they have $5000 debt on a credit card at 18%. What would you tell them?
Lama: That’s the thing, I wouldn’t tell them to take the full amount that they have saved and put it on their line of credit, because that amount that they have saved can be their emergency fund. So if something comes up, the car breaks tomorrow, if the roof collapses and they have that money set aside, it is not necessary a bad thing, they can use it to deal with their emergency versus putting even more money on their line of credit at 15%. So what I have a problem with is when you have $20 000 in saving and a huge balance on your credit card. But having a small portion in saving is a good thing, this is the emergency fund that I always talk about.
Tommy: BUt the emergency fund, if they pay down the entire $3000 they have 0 on their credit card they would be saving the 18% interest, and if an emergency came up their credit card is paid off, so they can put it on their credit card.
Lama: The thing is this strategy is more psychological. It is based more on psychology than actual math. The psychology a bit is that you know an emergency came up and I was able to deal with it without digging deeper into my debts. So psychologically you’ll feel better about yourself. Mathematically it doesn’t make sense.
Tommy: This texter says, isn’t a credit card for emergency?
Lama: No, an emergency fund is for emergencies. A credit card is just for the bank.
Tommy: Alright, Peter in Pointe Claire says, after reading Dave Ramsey’s The Total Money Makeover, I learned that cash is king and debt is dumb. I live debt free and I am now on the cash only plan, and it is so much less stressful.
Lama: Oh yeah, I love that book and I always recommend it. Actually what I just mentioned before about having cash on the side although you have debts it’s something Dave Ramsey preaches a lot about.
Tommy: What is the solution to somebody who has no credit card to spend, everything is maxed out and they can’t take a line of credit. What would you do to help?
Lama: This is where we have to look at your income coming in and where is it going out. And how can we find the funds to start paying down your debt, even if it takes you twenty years as long as you have a plan to pay it down.