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Friday, April 18, 2008

Basic Financial Advice

Today, I'd like to speak to a few points about finances. In general, borrowing money so that you can have something now, will, of course, cost you extra. That's the whole concept of interest which is paying to have access to money. Nobody likes to pay more for things, but when it comes to getting something earlier, people seem willing to cough up a lot more money without actually realizing it. Stop doing this! Get a dose of patience, save your money and adopt a pay as you go mentality. 10% or more of your paycheque should automatically go into savings, and you should consider it to be untouchable money in terms of your monthly budget.

In general, avoid borrowing money to buy depreciating assets.

The first big thing that you likely borrow money to buy is a new car. This is a rapidly depreciating asset. Instead, buy a used car. Get one that is just coming off a three to four year lease. Make sure that it is a make and model of car that has an excellent quality history. This car will still be a depreciating asset but the depreciation will not be as rapid as in those first few years.

The next big thing you will likely buy is your home. This is an asset that will likely not depreciate, but should track to inflation over the long term. Shop for your mortgage and negotiate! By getting the lowest interest rate that you possibly can, you will likely save tens of thousands of bucks if not more, over the life of the mortgage. This can equate to a 1000 dollars per hour of effort you put into this. So don't be an idiot, put in the effort and pay yourself this massive amount of money! Duh!!! If you can't manage this effort or detest negotiating, then at least consider going to a mortgage broker. Also, go with a variable interest rate if you feel secure enough doing so. Fixed interest rates are simply an insurance product. Insurance isn't free, this will cost you in terms of higher rates. But know the risks involved in going with variable rates. With the baby boomers no longer borrowing money but instead are investing, there is less demand for borrowed money these days and thus rates should remain relatively low for the forseeable future. Thus, in my opinion, the risk of going with variable rates is fairly low. Also, do not mortgage yourself to the hilt. Get something you can easily afford and strive to pay it off early.

My last point for today is bank accounts and credit cards. Are you paying money to a bank in terms of service charges or a service plan just to have an account? Please stop doing this and open up an account with the likes of President's Choice Financial here in Canada. This can save you well over a $120 per year in service charges. Also, if you are not paying off your credit cards in full every month, then cut them up. You are being severely gouged. Look at consolidating your credit card debt under a personal line of credit for a fraction of the interest you are being charged now.


mzalleycat said...

Hey Jim

Very interesting reading! Here's a question that's been bugging me for sometime and everyone I ask seems to have a different answer, and none of these answers ever appears to be backed by any evidence (ie., I've asked bankers and financial advisors, and neither appear to have justification for their answers). Here's my delimma: 10 years of student loans to pay off versus wanting to buy a house, versus "beginning" to save for retirement. Which should take priority? (keep in mind I pay very little rent). The longer the student loans take to pay back, the more interest I pay. The longer I rent, the longer I am throwing my money away. Once I become a homeowner, I have very little money left at the end of the month to pay back the loans, but at the same time, home ownership is an integral part of retirement savings, and what's the point of socking money away in retirement at the moment when I will never gain the amount of interest in savings that I will lose at the expense of not using that money to pay down debts. So which should take priority? What's your thoughts on the issue? BTW, the financial advisor advised to buy a home as soon as possible, the banker advised to put off buying a home and pay down the student loan. :)

Jim Somerville said...

Yes, this is a tough one. There is no really "correct" answer mainly because there are so many variables including non-numeric ones such as where you are in life right now and your priorities. But there may be an "optimized" mathematical answer for the state of things at the moment. It would depend on variables such as the size of your student loans, the interest rate on them and restrictions (ie. variable vs. fixed rates, are the loans fully open, etc). Other factors include how much RRSP headroom do you have, and what is your current marginal tax rate. You can dip into RRSP money for home purchase ie. the HBP. Another factor: home ownership has a lot of costs associated with it that should be factored in, from upkeep to municipal taxes to (possibly) condo fees, not to mention the taxes and closing costs just to buy one. Historically, over the last century, housing prices have only really reflected inflation. It is an "investment" that has ongoing carrying costs (upkeep and taxes), and you cannot really get the value out of it unless you sell. But you have to live somewhere, so it depends on how little you pay to rent right now. Rent does NOT necessarily amount to throwing money away. All that said, paying off loans has an instant known calculable impact. If you feel comfortable sharing some of your numbers in confidence, I can run some scenarios and see if there are any obvious optimization points.


Jim Somerville said...

Without knowing your exact numbers, I would probably recommend the following:
- look at making RRSP contributions with the idea that you will use the home buyers program (HBP), so these RRSP contributions are really just you saving towards your home downpayment. Also factor in spousal RRSP possibilities to maximize your tax refund.
- take your tax return money from the RRSP contributions and apply it against your student loans. Depending on your marginal tax rate and spousal RRSP possiblities (your spouse's marginal rate), the amount you get back from the government could be as high as 30% or more of the RRSP contribution amounts.

This scheme gives you the best of both worlds....reduces your student loans while allowing you to save for home downpayment. You will have to pay back the HBP amounts to your RRSP, but in doing so you are essentially just paying yourself and saving money towards your retirement.


JD said...

nice blog, Jim!!