Last month, the Bank of Canada issued a report highlighting the explosive growth of home equity line of credit use and mortgage refinancing in the past decade, which have surged from $8 billion in 2001 to $64 billion in 2010.
Canadians appear to be using these loans for two main reasons. They are either paying down other higher interest loans, such as credit card debt, or using the money for everyday spending.
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My first experience with a home equity line of credit was back in late 2005. After buying a house two years earlier, it surged in value during the economic boom in Alberta, rising from $129,000 to $190,000.
Using a Home Equity Line of Credit to Consolidate Debt
At that time, my wife and I still owed tens of thousands of dollars in student loan and credit card debt, so we took out a home equity line of credit to consolidate most of our debts. This was a smart decision that helped save us a few hundred dollars in monthly payments by lowering our overall cost of borrowing.
Just be cautious when using this approach. You still need the discipline to repay the line of credit or you might find yourself right back where you started.
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Our $25,000 credit line was borrowed at prime rate, and two years later we rolled the loan back into our mortgage at renewal time. The bank didn’t close the line of credit after this. Instead, they suggested we keep it open just in case something comes up.
Using a Home Equity Line of Credit as an Emergency Fund
Our finances weren’t perfect by any stretch. One or two missed pay cheques would have caused serious damage to our finances. However, building a cash emergency fund never became a priority for us because we knew we had a line of credit to fall back on.
So for the next five years our home equity line of credit remained untouched and we resisted the urge for that something to come up. During that time, I convinced myself that a home equity line of credit was the perfect emergency fund. Here’s why:
- A line of credit is the most affordable way to borrow for short term needs – with rates as low as prime or prime + 1%
- Accessing funds from your line of credit (once it’s set-up) is as simple as making a transfer online
- Re-payment of your line of credit is very flexible – you can pay as much or as little as you like.
- The opportunity cost of carrying thousands of dollars in a so-called high interest savings account did not seem appealing.
Using a Home Equity Line of Credit as an ATM
Meanwhile we watched as our friends and colleagues (and the rest of the country) tapped into their credit lines like a giant ATM and use it for home renovations, new vehicles, family vacations or to further their education.
In The Wealthy Barber Returns, author David Chilton writes that with our increasing debt load and infatuation with buying stuff, not only is a line of credit a bad idea, but it’s leading to over-consumption and we’re now carrying debt along side of our savings.
HELOC: Friend or Foe?
A home equity line of credit has its advantages. It’s an easy way for homeowners to consolidate high interest debt. When used responsibly, an untapped line of credit can make for a good safety net in case of emergency.
However, the easy access to credit and flexible repayment terms can make HELOC’s very dangerous. Many consumers dip into their line of credit and then quickly find themselves living at their limit. Then when the money runs out, they increase the credit limit and repeat the cycle.
Our home equity line of credit was closed when we sold our home last year. We rented for three months while our new house was being built, and over that time we saved up a few thousand dollars that we now keep in a high interest savings account.
We no longer have a line of credit, even with more than 25% equity in our home. Our new financial plan includes keeping cash reserves on hand rather than relying on a line of credit for emergencies. We want to pay cash for any major purchases in the future, like for a new car, basement renovations or a big vacation.
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For many people, a home equity line of credit is an easy way to fall into a debt trap. Be cautious. Don’t use a HELOC to continue increasing your debt load or to support a gap between your income and expenses.
I use a cash back credit card to earn credit card rewards on my everyday purchases and monthly bill payments. Since I spend the money anyway, I like to use the method of payment that gives me the best return.
You need to look at your overall spending habits to figure out the best credit card rewards for you. That’s because many rewards credit cards offer a higher rate of return when you spend a lot in a specific category, like groceries or gas.
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Maximize Your Credit Card Rewards
So if want to maximize your credit card rewards, consider using more than one credit card and let the spending category dictate which card you pull out of your wallet.
A good example is the MBNA Smart Cash MasterCard, which offers 2% cash back on groceries and gas purchases – up to $400 spending a month. I’ve been using this card for over a year and earned more than $700 cash back on my spending so far.
But I have a tough time maximizing the grocery and gas spending multiplier because I buy a lot of groceries at Costco – and they don’t accept MasterCard or Visa, only American Express cards.
Related: How to use your non-Amex rewards card at Costco
Last month I signed up for the True Earnings Card from Costco and American Express. With this card I get up to 1% cash back on everyday purchases – including at Costco. I also get 2% cash back on gas purchases and 3% cash back at restaurants.
I still use the Smart Cash card for most of my purchases, but now I use the True Earnings card whenever we shop at Costco and when we go out to eat.
For those of you who don’t shop at Costco regularly, here’s another strategy to boost your credit card rewards by taking advantage of category multipliers:
If you don’t mind paying an annual fee to earn more cash back, consider using the Scotia Momentum Visa Infinite as your main rewards card. This card comes with a $99 fee, but you’ll earn 4% cash back on grocery and gas spending, and 2% cash back on recurring bill payments and drug store spending.
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You only earn 1% on all other spending with the Momentum Visa Infinite, so consider using this card in tandem with a no fee card like the Capital One Aspire Cash World Master Card.
Aspire Cash gives you 1% back on your spending – no matter what category – but it pays a juicy 50% cash bonus every year on your card anniversary. This means when you spend $1,000 a month with Aspire Cash, you’ll earn $120 cash back, plus a $60 bonus for a total cash back rebate of $180 a year.
It’s easy to boost your credit card rewards by taking advantage of category multipliers and bonus offers. Just make sure you’re diligent about paying off your credit card in full each month or your earnings will be quickly nullified with credit card interest.
Last year the results from a Task Force on Financial Literacy were published and the findings were totally not surprising to me.
The Task Force defines financial literacy as “the knowledge, skills and confidence to make responsible financial decisions” that are applicable to the many decisions that people make on a daily basis – comparing prices at the grocery store, negotiating a mortgage, or making an investment.
Many Canadians carry too much debt, lead lifestyles beyond their means, have no savings/retirement plan and put too much blind trust in financial institution advisors to help them choose the right products.
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Out of 30 Task Force recommendations, the most obvious one calls for financial literacy to be taught as part of the regular school curriculum throughout Canada.
The role of financial institutions
I found it interesting to note that the financial institutions were quick to applaud the report. After all, increased savings benefits them. According to Nancy Hughes Anthony of the Canadian Bankers Association, “banks recognize that they have a shared responsibility in contributing to financial literacy.”
However, financial illiteracy is exploited by the financial services industry.
- Do mutual fund companies want the public to know that ETFs are less costly than mutual funds?
- Do credit card issuers really want debtors to know the ill effects of paying only the minimum monthly balance?
- Do life insurance companies really want us to buy low cost term life insurance instead of the more lucrative whole-life policies?
- Why do financial advisors sell complex products that are difficult to understand?
Banks rarely offer good unbiased advice such as discouraging someone from contributing to an RRSP when they have excess debt.
I would like to see them give better (and easily accessible) information on their products. How about offering low cost (or free) chequing accounts and low interest credit cards?
Failing to take free money
Many seniors are missing out on government benefits because they don’t apply for them. The Task Force says that 160,000 eligible seniors don’t get Old Age Security ($1 billion worth), 150,000 don’t get the Guaranteed Income Supplement, and 55,000 aren’t getting CPP.
Many seniors also do not take advantage of the many discounts available to them for movie tickets, banking services and restaurants, to name a few.
Related: How CARP Benefits Aging Canadians
Only 40% of those eligible take advantage of the Canada Education Savings Grant. The median RRSP contribution represents only 6% of total eligible room.
When employees decline to join the company pension or employee savings plans they are giving up free money if the firms match their contributions.
People who fail to contribute to their Tax Free Savings Account are passing up tax-saving opportunities that could improve their financial position.
Too little preparation for retirement
A number of surveys show that we aren’t saving enough for retirement. Canadians don’t have the financial knowledge or the capability to plan for it. Few are aware of the retirement savings options available to them, or even of the particulars of their own company pension plans.
The shift away from defined benefit pension plans, which provide predetermined dollar payouts to defined contribution plans, which must be managed by the individual can reduce the income of retirees substantially.
Final thoughts
Financial literacy is a lifelong pursuit. Questions differ depending on the stage in life. High school students want to know how to save for new clothes or entertainment. University students need to know what it costs to live on their own, how to manage their student loans and how to start investing.
Those recently married want to pay down debt, save for a down payment on a house and negotiate a mortgage. Retirees want to convert their investments into income.
You don’t have to be a math whiz. It’s not complex. The basics of personal finance are – make a budget, spend wisely, pay off high interest credit card bills and other debt, save for the future, have the proper level of insurance and be tax aware.
Related: The Best Time To Start Saving Is Now
With all the information available on TV, newspapers, magazines, and online there’s no excuse for the shocking lack of financial knowledge that most of us have. Choose your own destiny, or someone else will.