How bad an idea is this? (Debt-related.)

In My Humble Opinion
1

My husband and I had a five-year plan for fixing up our house and selling it for a profit to pay off our ~$40,000 worth of unsecured debt, then buy another house with no other debt. Well, the housing market in Calgary has probably put an end to that fine plan, so we need another plan to make our debt go away. We’re right on the bubble - we make enough money each month to pay down the debt slightly, but we’re being hammered so hard by interest that way more money goes to interest than debt reduction. My new plan is to possibly increase the amount of our mortgage when we go to renew in 2.5 years, and use the extra money to pay off the other, higher interest but unsecured debt.

I would not normally consider turning an unsecured debt into a secured one (like a mortgage), but the real estate market in Calgary means that we would have approximately $175,000 in mortgage on a house that we can sell for $300,000 (we bought a fixer-upper for a fantastic price just before the market skyrocketed), and no other debts (except the car payment). Making all the extra payments allowed on the mortgage would allow us to pay off the full amount in five years, which we could possibly do once we stop paying so much in interest every month.

What do you all think? Good idea? Bad idea?

2

Sounds like a good idea to me, and really not that odd of one. I think I’ve done this before myself.

If you look at your investments and debt not as “secured” and “unsecured” but rather as assets and debts, then things get very easy. If you have $300K in assets in the form of a house, then a $175K mortgage against it is nothing, even if you use some of that mortgage money to pay off your credit cards (or whatever.)

In addition, at least here in the US, mortgage interest is tax deductable. Even if that’s not true north of the border, I’m guessing the interest rate on a mortgage is MUCH better than you’re paying on credit cards.

In short, I’d do it.

3

I agree with Athena. The only risk that I see is an avoidable one, but one which one friend of mine fell prey to. Within a few years of converting his credit card debt to mortgage debt, he had run up a serious amount of credit card debt again.

4

Crotalus makes a good point. This makes sense as long as it is part of a serious effort to pay off debt and not just to free up more available credit card funds

5

I’m in the UK. My bank gives free financial advice. (Obviously they hope you’ll use their services, but their suggestions have been fine.)

I agree with Athena that mortgage interest is going to be lower than credit card rates.

And what Crotalus said. Borrowing money on credit cards is very expensive.
Always try to pay them off in full each month.

6

Is it even necessary to do this only when you renew in 2.5 years? Why not secure a home equity loan now, pay the cards off entirely, then pay off the HE loan over time at the lower rate? You’ll save a ton on interest over those 2.5 years.

7

Ah, good feedback, guys. I hadn’t thought of looking at debt like that, Athena, and that makes perfect sense. I also hadn’t thought of getting a home equity loan, because I had the idea that borrowing against your house is BADBADBAD (which was basically what I was planning to do, but sometimes you need other people to tell you where you are). But in light of how much our house is worth and how much we owe against it, we’d be pretty safe - if we were in serious financial trouble, we’d just sell the house for almost twice what we paid for it and pay off the mortgage and HE loan.

Also good points about getting back in debt again. We’ve been pretty disciplined at living within our means for a while now - I’m cautiously optimistic that we’ve learned our lesson the hard way.

I think I need to call my bank. :slight_smile:

8

Oh, I should mention, glee, that in Canada, banks are one of the biggest scams going (second only to insurance companies), so you must be careful to take any advice from them with a truckload of salt. The banks here will only tell you what benefits them and only let you do what benefits them - probably no different from banks around the world.

And we don’t get to claim our mortgage interest on our taxes, either. That’s one thing you 'Murricans have all over us. :smiley:

9

Uh, why? That doesn’t make any sense.

The first thing you should do in any financial plan is to figure out what YOU want, and then figure out how to get there. I may have missed it, but I’m not sure you’ve clearly outlined that for us. If your sole objective was to accumulate more wealth, maybe the best thing to do is to sell the house and move to Winnipeg, if your objective is a new Mercedes, then your plan will be different. Banks and financial advisors never really like to admit it, but rememer that we’re all dead in the long run, and I doubt most people live with the goal of dying on the biggest pile of cash.

Saying “x type of debt is just bad for you” is kind of like saying “all meat is bad for you”. You need to consider everything in terms of risk, return and time value of money. Would you doubt that a new Mercedes when you’re young is worth a lot more than a new Mercedes when you’re sixty? Try figuring that number into a financial plan and you’ll see what I mean.

10

I was about to post a question similar to the OP. We will be meeting with a mortage company later today to see about a few things:

  1. refinancing our current home loan;
  2. what kind of rate/payment plan could we get w a house we’re looking at now; and
  3. doing a home equity loan to cover our unsecured debt, somewhere about 40k.

(We seem to have plenty in common featherlou.

We’ve built up perhaps 40k in equity on our current home but are anxious to get out of there, possibly into this great deal we found in a super neighborhood w good schools (working on the kid thing, a subject for a different thread). We did a breakdown of our unsecured debt and the interest we were paying and it just makes little sense to try knocking that down a bit at a time when we could take care of all of it at once. Granted, thats on a longer term note (we’re hoping for 10 or 15 years and this company claims they can get us in “well” below prime, but it beats deluding ourselves w minimum payments on 18% cards.

As others have said the key will be avoiding debt buildup on the cards afterwards, which I don’t see being a problem given some of our unique circumstances which are entirely too dull to get into here.

I’ll update w feedback from the mortage folks later.

11

Unsecured debt is basically written off in a bankruptcy situation (short answer, I know); secured debt is secured by something of value (a car, a house, etc.) that they take away from you if you default on paying. That’s why financial planners often don’t recommend going the Home Equity Loan route - taking out a $10,000 loan on your $250,000 house, and then losing the whole house over defaulting would be financially moronic.

Good question about our financial goals - our immediate goal is to become debt-free. We have small RRSP’s (retirement savings plans) that we contribute to regularly as well, but our major financial focus is reducing our debt load. A significant part of our retirement plan is to have very little in expenses, and that includes no mortgage. After the debt reduction is done, we can focus more strongly on putting money away for our retirement and paying off the mortgage.

12

Do you live paycheque to paycheque? What are the chances of you defaulting on the loan and being forced into bankrupcy? I’m not saying it’s impossible, but it seems a little strange to base your entire debt strategy on the risk of eventual bankrupcy over a measly $10,000. if your situaton was that precarious, perhaps the best thing to do would be to reduce expenses, take on insurance to cover against any contingencies and focus on becoming less leveraged? I’m not in your situation but can’t even imagine taking out unsecured consumer debt and paying the corresponding rates for ANY reason, much less the (for me, I’m 23 and healthy) non-existant risk of bankrupcy.

13

Yup.

Slim but real.

I’m sorry, I don’t understand this at all. The $10,000 was just an example, not what we would actually be looking at, and most of our unsecured debt at this point is low-interest lines of credit rather than credit cards. We have tried to consolidate our debts to make repayment easier for us, but the banks aren’t interested in that. If we go the route I’ve described with increasing our mortgage, it meets all our our criteria - low interest and consolidated. My concern was changing unsecured debt for secured debt, but as you can see in my earlier posts, I’ve worked that out already.

I don’t know what “less leveraged” means.

14

Well, this is all IMHO, since as I said, you’re the only one who knows what you really want, but if I were you, I would pull the equity out of your home and pay off the unsecured loans ASAP. Assuming that you don’t have any sentimental attachment to the house or anything. Unless you actually PLAN on declaring bankrupcy and defaulting on your loans, I can’t see any reason why you as an individual should use unsecured debt versus secured debt. The higher interest you pay on those unsecured loans is to compensate the bank for the risk of you going bankrupt, and since I don’t intend on declaring bankrupcy, I don’t feel like paying them for the risk, and I would rather sell the Mercedes.

But I can’t emphasize enough: You’re the only one who knows your risk appetite. I’m a fairly cautious type who doesn’t like living on the edge, maybe you do, so YMMV. :slight_smile:

15

Leveraged basically means investing borrowed money. Leveraging has the effect of amplifying whatever gains or losses you experience. Houses are traditionally highly leveraged investments. You “buy” a house for only about 10% of the cost up front (or, more recently, none of the cost). If it goes up in price 10%, you just made 100% on your money. But if it goes down 10%, you just lost everything.

Generally, though, since money is fungible, you can consider how leveraged your entire financial portfolio is, not how leveraged an asset is. In general, any time you have both debts and assets, you are leveraged to some extent. Consider two individuals, one with $100K in debts and $110K in assets, and one with no debt and $10K in assets. Both have the same net worth, but the first is much more leveraged than the other.

Leverage can be a good or bad thing, depending on how you use it, but it is almost certainly a bad thing if you have high interest debt and low-return investments. In your case, consider your retirement accounts. I don’t know how retirement accounts work in Canada, but unless you get some absurd tax/employer contribution advantages from the retirement account, it’s a poor plan to pay into the retirement account at the same time you have consumer debt. Think of it this way: If you had no retirement savings, would you borrow on your credit cards at 15 or 20% in order to put the money in your retirement account? Probably not. What about your other assets? If you had a lesser car than you drive right now, would you borrow on the credit cards to buy a better one? If not, then sell the car and pay those debts. The car probably wins out over the retirement account, because it has a lower rate of return (negative, probably), but they’re both a worse deal than paying off the debt.

For an example of where leverage can be a good thing, I’ll use one that I see among my contemporaries. An individual’s got $15-20K in edu loans, but is paying them off as slowly as possible, while putting money in a retirement account and making other investments. Why? Because they got a very low rate on those loans, and can make more money even with conservative investments like CDs (even after taxes) than by paying off the loans. Note that because of the conservative investments, in this case the leveraging of assets doesn’t actually increase risk, although that’s not usually the case.

If that was unnecessarily simplistic, I apologize. FWIW, I agree with those who say to get a lower rate on that debt as soon as possible, and to continue living below your means to pay it off as soon as possible.

16

Well, it isn’t ABSURD, but it is significant. You are allowed to contribute a set percentage of last years income to your RRSP and deduct that amount from your income. This is significant since our lowest tax bracket around here is around 25.5%, and if you are making more than min. wage and not going to university, that’s an automatic 25.5% return. I would probably still pay off the debt first, since RRSP “contribution room” can be carried forward, but if featherlou really does have very low rates for her consumer loans then it might make sense. There’s a few other quirks in the system for using RRSP contributions to buy a house and what not, but it’s generally a pretty good investment no matter where you are in life.

My first leveraged investment was with an RRSP. When I was 18, before going on my first overseas vacation with the army, I borrowed $4000 in an RRSP loan at prime-1% (!), put it in my RRSP fund, and paid the loan back at the end of the year with what wages I had left from the boozing. My RRSP funds grew 9.5% that year, plus the 25% in tax credits. Interest on the loan worked out to be about 3.76%. :stuck_out_tongue:

17

Good point. My first guess was that someone with $40K in consumer debt probably did not have particularly low rates, but they might be low enough that it’s worth paying into the retirement account instead of paying them off.

Are the RRSPs tax-free, or just tax-deferred? You can’t count all the tax savings as gains if you’re going to have to pay taxes later. Some, but not all.

18

If you all were smart, you’d take the money out of the house and invest in a FD3S Mazda RX-7. By the time they become street legal here next year, all the Asian kids who saw the last Fast and Furious movie will pay you double what you paid to get there hands on one of these. :slight_smile:

DISCLAIMER: I am not in any way affiliated with the above company, nor do I plan on spending my own investment money on an unreliable 15 year old Japanese car, but whoever actually does would be totally awesome, and most likely WILL make at least some money.

19

Sorry, tax-deferred, as in you pay income taxes on them when you withdraw them, but no Cap gain is assessed on the funds growth as long as they remain in registered status so the growth is sheltered.

20

Sell your place, if you can, pay off your debts, invest the surplus conservatively, and rent.

That’s what I’d do. But then I think there’s a great big housing bubble in the US that may drag the entire world economy down with it. Others disagree.