12-Minute Financial Makeover Step 6 - Ease Your Mind with Debt Freedom Plan

This is the 6^th installment of our Financial Makeover Series featuring carefully selected personal finance subjects. We hope talking about these basic principles can allow you to figure out what can help the most in your own unique situation.

We talked about avoiding fees in Part 1 and how using a no-fee online checking account could help you so.

Part 2 featured spending more on things you truly love using a fun budget approach.

We continued in Part 3 with the amazing freedom of budget choices that can allow you to realize more of your projects and dreams.

Part 4 talked about emergency savings and having a personalized contingency plan.

Part 5 suggested to hammer down boring big recurring expenses.

After these, we now feel ready to abort an even more challenging subject. So, let’s put on our armor, sharpen our sword and face on the dreaded debt beast.

 

The Right Mindset

Having too much debt is probably today’s biggest financial problem of too many families. We did not start our Financial Makeover Series here because we believe it’s better to have developed some tools before tackling on dreaded debt.

 

With some confidence in your abilities, getting out of debt can be quite straightforward. You just have to allocate money in the right way to achieve it.

 

We know getting out of debt may seen difficult or even impossible for some. Many are even addicted to debt. They know extensive use of it is bad for them yet became comfortable bathing in it. Sadly, they are so afraid about getting into that battle.

 

But after you get over that steep psychological hurdle, getting rid of debt becomes basic math. You have to believe and decide you can get out of debt. No one can do it for you. You have to commit and do it for yourself and your family. The good news is that you have that power in you.

Think Twice Before Committing to The Home Buyers’ Plan

Today, we’re going to talk about one of our biggest financial mistakes over the years. It relates to the appealing Home Buyers’ Plan (HBP). Our young selves happily lunged into it acquiring our present house more than 15 years ago. At the time, it seemed like a very wise decision and the strategy provided us with a substantial chunk of change that greatly helped us in the short term. With retrospect, it now looks more and more like a very poor financial choice that considerably cost us in the long haul.

Everybody would love to, one day, have a nice home. For many, owning a big house is synonymous with financial success.

For most young folks, becoming a homeowner seems like a steep financial achievement and many may think it will remain only a distant dream. Then, they hear about the Home Buyers’ Plan (HBP) and their dream suddenly becomes more accessible. They see no-hassle free money that potentially can boost their house down payment (maybe a mistake). For some, the HBP may even provide the only cash to finance their once unattainable dream (definitively a mistake).

Fiscal Debt That Can Have Significant Long-Term Repercussions

The HBP allows you to avoid paying taxes on some RRSP withdrawals if you use those funds to buy your first house. After a two-year grace period, you have 15 years to repay your RRSP. The problem is that for most participants, the resulting tax bill will end up costing them much more in the future. The long-term implications and financial impact of that heftier tax bill cannot be ignored.

It makes no sense to withdraw from your RRSP avoiding only a 25-30% tax bill and later, to repay your RRSP with an ensuing 45-50% tax cost.

Fixed vs Variable Mortgage Rate Mistake

In the fixed-versus-variable mortgage rate debate, one cannot argue that historically, variable rates have been a better long-term option. There’s still some risk associated to the variable option if interest rates happen to rise. With the fixed option, you are basically offered to pay a premium to kind of take out that risk.

But things are not that simple and obvious. In practice, rates would have to rise fast and rise a lot to really hammer down the variable option and make it the worse choice. In the end, in most cases, the fixed rate premium may simply be too costly. At least, that’s what we learned from our personal experience.

To make a long story shorter, we started our mortgage life using the optimal variable-rate option for the first 5 years. In 2006, we switched to a fixed rate afraid of a hike. In fact, that dreaded eventuality only manifested itself timidly more than 10 years later, in 2017. Choosing the fixed option was a mistake. That huge misstep cost us about 10K$ only in interest in the following 5 years. Because the amazing power of compound interest works both ways, our mistake surely cost us thousands more since then.

Drawing conclusions may be easy after the fact, but this is a classic case where your emotions get in the way of sensible financial decisions.

In late 2010, we were already convinced about Variable Rates being The Right Long-Term Choice For Our Mortgage yet we struggled and still made what appears like the safer choice locking in a fixed rate for 5 more years.  With retrospect, that decision was not as bad because the spread between variable and fixed rates remained much smaller. In the end, it looks like it will cost us only a couple hundred dollars more.

The great news is that our mortgage is now virtually paid off, eliminating additional opportunities to make the same mistake again and again.

Still on the bright side, we are doing very well financially despite several mistakes of the same magnitude. It looks like it's not about being perfect, but rather more about learning, working thru it and being good on average. 

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Ideas to Deal with Rising Mortgage Rates

On September 6^th, the Bank of Canada implemented its second rate hike of the summer. We must assume it’s only the beginning as the Canadian economy has been doing quite well. Essentially, rising interest rates is the main option for the Bank of Canada to keep inflation under control in booming economic conditions.

As a result, Canadians can expect borrowing costs to get higher. In that context, the principal preoccupation of many house owners is having to pay more for their mortgage.  

So, what can we, simple mortals, can do about it?
  

Stay calm as you probably have time to adjust

Stay calm! There’s nothing critical yet. First, significant hikes won’t happen overnight and will be gradual. Second, effect may not be that immediate so you still have time to prepare for adjustments. Online mortgage calculators can allow you to anticipate eventual increase of your payments.

For very popular fixed-rate mortgages, payments won’t be affected till renewal. Many variable-rate mortgages involve fixed payments also only affected at renewal. You’ll end up paying more interest and your balance will accordingly be a little higher.

Get To Financial Independence Quicker With a Smaller House

Living in a smaller house might be one of your most important decisions on your way to financial independence (FI: I like to define financial independence as being wealthy enough so you can choose to work or not). Rest assured, I’m not talking about those tiny houses that seemed to be popping all over. Rather, I think you should own a regular house, only a tad smaller. As we will see further down, downsizing only 20% could get you a long way towards FI.  

Not only will it reduce your mortgage payments but also many other related expenses. Hence, a more modest home will automatically result in less property taxes, less insurance, less maintenance/repairs and also a much more affordable utility bill... Ultimately, it may also save you a lot of time.

A little more than 15 years ago, our frugal nature enticed us to buy a smaller house and we now realize all the benefits of that decision. One of the most interesting consequences will be that we will get to financial independence much faster.

I decided to do some digging on this subject after I played golf with Alvin, a distant acquaintance. Alvin inherited some money and a fancy house in a rich neighborhood from his uncle 2 years ago.

Avoid Wasting Money on Costly Mortgage Insurance

A few weeks ago, two people asked me questions regarding the same subject, their mortgage insurance; they were concerned and had some doubts about it.

My initial intentions on the matter were to quickly write about them while adding brief comments. I started my draft. But ideas kept coming the more I thought about it.

After a while, I finally decided to let my mind go on and freed up my pen (it’s more like my keyboard but you know what I mean); a «quick beef» post transformed into a much more elaborate article.

So here’s what came out of it. Hope you like it! 

The conversation I had with those folks reminded me of an Article I wrote back in 2010. Looks like the financial institutions are still singing the same old tune.

It was kind of late for them because it seemed like they already wasted a lot of money on these products, but as they say, better late than never.

With their permission, I will abort the outline of their respective situations. Afterwards, exposing my point of view, I’ll share with you 12 Helpful Tips about Mortgage Insurance.

Note that to protect their privacy, some figures have been altered and rounded up, irrelevant details may also have been omitted but the spirit of each situation was respected.

The Average Person Pays Too Much

First off, my neighbor (we will call him Joe) is renewing is mortgage soon and did not really know how much his mortgage insurance cost him so far.

Almost Always Waive Life and Disability Insurance Clauses on Loans

When you borrow from financial institutions, they systematically offer you life and disability insurance to «protect» your mortgage or loan.

It might be wiser to waive these insurance clauses and thereby avoid paying «small» supplements.

Indeed, most of the time, loan insurance clauses are simply not beneficial to you.

Less Expensive Possibilities

You need to check and compare it with other options available to you. But in most cases, it’s possible to obtain similar protections cheaply.

Thus, Group Insurance available through your job is often interesting and can fully cover your insurance needs at a low price. There’s absolutely no point to have double or triple coverage; you’ll probably only get paid once anyway.

In addition, it is always advisable to combine coverage on a single contract to avoid undue administrative costs.

Take Pre-Approved Mortgage With a Grain of Salt

Dream House

Sunday morning, Mister and his tender half, dream of more space. They think of moving out of their tiny apartment. In fact, they hope they can finally afford a cozy house: their first house.

Mister proposes to contact their bank as of the following day; two days later, they suddenly sit in front of the nice mortgage clerk. After some quick questions, some fast typing and several smiles; a sheet is frantically printed in the adjacent room, the verdict is out: $300,000!

Wow! Our young couple is ecstatic, they can stop to dream of a house; they now can afford the house of their dreams! And all this, despite their income…their modest income.   

But their dream will probably transform into a nightmare if they don’t wake up soon. At this moment, they only think of their house; their castle in fact. They don’t think of the financial burden, the high monthly payments of more than $1900 (@ 6% over 25 years) and of all the expenses that come with a big residence.

Shop Around and Negotiate Your Credit Conditions

Always Worthwhile to Negotiate

It may be interesting for you to shop and negotiate loan or credit line conditions with a few different financial institutions.

On your mortgage, for example, a difference of only 1% will save you tens of thousands of dollars in interest before you finish paying your home.

Consult Several Institutions

Avoid being lazy and get information elsewhere. At worst, negotiate with your regular institution to obtain the best possible terms afterwards.

The Right Long-Term Choice For Your Mortgage : Variable Rates

History Favors Variable Rates

Interest rates are far from being an obvious issue; we take a chance and venture a guess on what’s going to happen next, but in most cases, variable mortgage rates will be the right choice.

Indeed, historically variable rates have been lower than fixed rates. A variable rate would especially be beneficial if a decrease in rates can be anticipated or even if rates remained relatively stable.

However, a variable rate will not benefit you if a rate increase is anticipated. Thus, the fixed rate today can be lower than the variable rate in a few years.

Fixed Rate Premium

You take a certain risk with variable rates, it’s only normal to be rewarded by a lower average rate.