The Debt Edge

The use of debt in your financial affairs is akin to a double-edged sword. On the one hand, it is very useful to assist you in buying and owning assets using "other people's money (OPM)" such as a home or other financial asset. On the other hand, it can be a problematic tool to use in the event of a job loss, cash flow interruption, recession or rising interest rates amongst various possible scenarios.

While we have been in a credit/debt-based economy since at least the end of WW II, there are two things now that may mark an inflection point in the advisability of using debt as a financial planning, asset-building tool.

The first point is trying to be a contrarian as a way of standing apart from the crowd and doing what most other people are not doing – reducing debt while the rest of the world seems to be slipping further into debt with each passing day. Everywhere you look, debt levels are at record highs for governments, Canadian consumers and even corporations. The challenge is to plan for the day when debt is no longer so favourably looked upon as a mainstream planning tool.

The second point is to recognize that falling interest rates, since the peak in 1981, has made it easier and less expensive to carry the same or greater debt for the same cash flow cost. This trend has likely ended following a decade of near zero real interest rates. The Canadian and US Central banks have been slowly increasing the prime interest rate for the past year or so. This is being reflected in slightly higher mortgage rates, and personal line of credit rates, amongst other interest sensitive consumer products.

From a planning perspective, it may be prudent to consider that interest rates will likely continue to climb, albeit in a zig zag pattern over the next 5 years or decade or more. You can conservatively plan for this in your cash flow and budgeting to assist you in adapting to this possibly new long-term reality.

As you may have noticed, it is relatively easy to get into debt, but it seems to be much harder to repay that debt. Here is a look at why that may be the case:

Let's look at Mary and Bill as an example. They are able to pay $10,000 per year in debt and carrying costs for their mortgage. With an interest rate of 10% they could afford a mortgage of $100,000. But as interest rates fell to say 2% they were able to carry debt of $500,000 for the same annual payment.

Now the challenge comes as interest rates slowly turn the corner and start to increase. At 4% mortgage rates, the annual cash flow becomes $20,000 or double what it has generally been.

It may take time for any interest rate increase to affect you personally as you may be insulated because your mortgage or other debt does not come up from renewal for some time. But make no mistake, wise investors are thinking ahead now for how they will manage this new reality.

The key is to pay off credit card debt, car loans, credit lines and other consumer debt today and as soon as possible. In doing so, you will be given more flexibility to meet any increased mortgage costs over the next several years. This is very important in cities and areas such as Vancouver and Toronto and others that have experienced strong real estate markets and much higher mortgage debt levels on average than other parts of the country.

Call us today for a meeting to review your cash flow and debt situations.



Copyright © 2018 AdvisorNet Communications Inc., under license from W.F.I. All rights reserved. This article is provided for informational purposes only and is based on the perspectives and opinions of the owners and writers only. The information provided is not intended to provide specific financial advice. It is strongly recommended that the reader seek qualified professional advice before making any financial decisions based on anything discussed in this article. This article is not to be copied or republished in any format for any reason without the written permission of AdvisorNet Communications. The publisher does not guarantee the accuracy of the information and is not liable in any way for any error or omission.

What our clients are saying...

  • I appreciated feeling valued as a client. It was a pleasure to have uninterrupted meetings. The reports were very detailed and tailored to me and all the explanations were very clear. It was refreshing not to feel pressured into anything as I have felt in the past. My expectations are to have regular updates/check-ins to see how the market is doing and to discuss any strategies, opportunities that may be relevant to me. My experience with Anthony has been great. I would be happy to recommend him.

  • When working with a financial planner, my expectation is to work with someone who is responsive to changes and who can devise a path forward as we age for the benefit of ourselves and our children. I valued the depth of detail and explanation along with the disclosure of all the variables at play. I would certainly recommend Anthony to my family and friends!

  • I was looking for a financial planner who could provide clarity and show me the best possible way to structure and plan for my retirement. Anthony’s expertise was clearly evident. He is professional, punctual, and answered all my questions and concerns. I would definitely recommend Anthony to my family and friends.

  • We expect a Financial planner to be thorough, detailed and have a strong understanding of their clients' needs. It was a pleasure working with Anthony and his team. He delivered a tremendous package and reviewed his findings in great detail. Anthony's attention to detail, solutions, recommendations and in-depth reports provides a great deal of confidence in his recommendations. We would absolutely refer our family, friends and associates to Anthony.

  • I expect my financial planner to review and discuss my financial goals along with how my goals can be achieved. I valued Anthony reviewing my investments and the projections of what they will equate to when I reach my eventual retirement. Anthony has certainly met my expectations and I would be happy to refer my family and friends.

  • My expectation was to be provided with the best possible advice specific to my situation (as it evolves) and to be provided with objective, evidence-based solutions which will provide me with the maximum financial benefit (and peace of mind). I valued the very thorough process of gathering all pertinent information regarding my estate, pension, income and expenses in order to produce a very detailed and fulsome projection of my current and future financial situation. I really appreciate the time Anthony has taken to answer all of my questions and provide sound advice based on my goals and concerns. I am really looking forward to continuing my investment and financial planning journey with Anthony. I would certainly recommend Anthony to my family and friends!