When you need to borrow money

Part II in a short series on personal finance.

Having spent many years in finance, I can recall young (and not so young) people coming to me for loans for cars, and couples looking for mortgages. Going through the application process was often the first time they were asked what they owed and what they owned, how many places have they lived in the last three years and to supply three years of tax returns. 

This is also the time to confront the fact that their income may or may not support the loan or mortgage they are looking for. 

Today credit is made readily available, but it can be a real economic trap. One trap is the compound interest calculation. Here’s just one example. Ads featuring brand new small SUVs are a real craze. I looked through some recent ads and found one: No money down and only 64 dollars per week for seven years. (Ever count the number of cars on the road that are older than seven years?)

The cash cost of the car is $22,410, but that amount financed over seven years at 1.99 percent equaling 64 per week will be $23,296. The difference in interest is $886. That might not sound like much, but when you turn this around and say you saved $64 per week for seven years at 4 percent (which is what you can earn if you buy shares in any Canadian bank – on March 18, 2021, BMO was 3.80 percent.) Were you to do that for seven years instead, you’d get $26,800. The opportunity cost between buying on time and interest vs saving on time and interest is $4,390. That is 20 percent of the cash price for the car. That does not mean you should not do it, but be aware of what you are getting into.

Home sweet home

Housing and mortgages are a bit more complicated. Declining interest rates have caused a spike in housing prices almost Canada-wide but most pronounced in our bigger cities, especially around Toronto, Vancouver and Montreal. Housing statistics are difficult to pin down, but I found the following listings for a 1,000-square foot condo in the following places: Vancouver, $1.1 million; Calgary, $500K; Winnipeg, $350K; Burlington, $550K; Montreal and Halifax, $500K.

To buy a home with a high ratio (more than 75 percent borrowed) mortgage, you also need special insurance, which can add thousands to the borrowed amount. Also interest rates, applied on application, have been artificially raised to make sure the buyer can afford a higher rate on the longer term.

There are some terms people need to get familiar with. One is the ability to service your debts. The rule of thumb for mortgages is that banks will allow up to 32 percent of your combined gross income as a mortgage payment. Gross income of $5,000 per month will allow a $1,600 dollar mortgage payment. But the bank also assumes you have credit cards and will allow about 35 percent for what is termed “total debt service ratio” (TDSR). Here is where things get interesting. A large credit card limit puts pressure on the amount of mortgage you can qualify for. Banks pretend that you must make a 3 percent payment on your credit limit every month. For a credit card limit of $10K, that is a projected payment of $300. Your $1,600 mortgage payment plus your $300 CC payment becomes $1,900 total payments, which as a percentage of $5,000 is 38 percent, so suddenly you only qualify for a $1,450 mortgage payment. (1,450 + 300 = 1,750 = 35% of 5,000!)

But it is not uncommon for folks to have more than one credit card, and they may also have consumer cards from Canadian Tire, jewelry stores, the Brick or some other furniture store. Young people with student loans still outstanding will be quite surprised that they may not qualify for the total mortgage they want because of this combined debt. 

In our Christian communities, it is quite natural for young married couples to want children. When this happens, it puts a damper on double incomes. Here is where families, parents and grandparents can play an important role. 

In some locations, parents or grandparents may have gained a lot of equity in their home because of where they live. If they have not used this equity, it might be possible to use it to provide children with a partial down payment. Where there are multiple children this should be discussed with the whole family.

The bottom line is that you need to be aware of what you owe and what you own, before you head to the bank looking to borrow more!

Part one and part three of the series.


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