[Vej]

Hi All,

First time here, glad to meet you all!

I have a the following financial standing:

Coast Cap Line of [email protected]% -6112
Coast Cap RRSP 1yr [email protected]%(matures in Dec09) 4325
Scotia auto loan @12% -11000
CIBC [email protected]% -15457


I'm a permanent salaried employee. 90,000 per year, I rent, no other significant assets.

My plan, that I'm hoping the experts here will either shoot holes in, or validate is as follows:

I just sold my public company shares and now have $8500 in cash. I plan to put this into an RRSP (not sure what type yet). With that in place I'm hoping to a bank will lend me $19,000 to consolidate my auto loan, line of credit, and credit card. My rationale is that the RRSP will save me a lot in income tax, and offset capital gains on my sale of shares, I'm also hoping it will make me a more attractive borrower to banks. The consolidation loan will reduce my interest significantly, and I will take it over a short period of time so I pay it off quickly and can get to some real saving.

Is this a good plan? Or can I do better?

Thanks!

 

[Four Pillars]

I think your plan is good however the complaint against loan consolidation is that having an empty LOC (or credit cards etc) can be very tempting and some people will start borrowing again and end up with more debt then pre-consolidation.

In your case I would want to know why you have so much debt and negligible assets given that you have $90k in income and no house? Unless there are extenuating circumstance (ie you just graduated school) then you should really look at putting a proper budget together and cut your spending. Once you are confident that you have a handle on your finances then you should do the consolidation.

 

[Vej]

Hi Four Pillars,

Well observed. My situation is due to extenuating circumstances due to a former employer not paying, and a period of unemployment. 12 months ago was the first time that I ever held any significant debt. I don't intend to make similar mistakes again!

As for the credit available to me after loan consolidation. I plan to reduce all my limits drastically, as I don't need and I don't want that much credit available to me.

I have adjusted my spending and lifestyle, and I continue to make better use of my disposable income.

Given that, do you think this is a reasonable way to go?


I plan to ask my credit union for the debt consolidation loan, however, if any one can recommend other suitable products, I would be keen to hear!

Cheers,

 

[investnoob]

Aside from the 8500 coming your way, do you have any cash at all?

If not, I'd say do as Four Pillars suggested. Get a budget going so that you have a plan in place to attack the debt.

By my count you have about 32K in debt.

With the 8500, you could set aside 1k for emergencies, enough to pay the gains taxes, and use the rest to pay off your line of credit. This would free up cash to place on the car loan, or visa debt.

In the end, if you consolidate, I don't think you would really pay off the debt that much faster. What would make the most difference is figuring out a budget and sticking too it until its all gone. I think you would be surprised by how quickly you could pay all this off with your income. If you got really serious about it, it could take less than a year.

 

[Vej]

Hi Investnoob,

I think your right that I can make quick work of my debt given my income. You are also correct that I'm carrying about 32K in debt.

However, I'd like to explain my rationale a little more to see if it is sound.


By putting my $8,500 into an RRSP I will save a lot of tax at the end of the year. I'm in the higher income tax bracket after all.

By getting a loan to consolidate my debt, I will reduce my interest fees on that debt significantly, and it will allow me to put aside cash on a monthly basis to pay off the consolidation loan early. I failed to mention this as my intention earlier on.


I realize that I'm simply moving my debt around, and without a solid plan, I may not actually reduce my debt at all. I need to pic myself to a solid plan. Assuming that I do, do you think my strategy is good provided that I am strict with myself?

 

[Vej]

Investnoob,

I didn't answer one of your questions. I don't have any other cash on hand besides my job income, which goes straight to my LOI and then to my Visa. I tend to keep my LOI near its limit and pay off my Visa as much as possible, as the interest rate on my visa is 19%.

Before I reduce my credit limits, I will put away ~$2,000 as an emergency fund.

 

[investnoob]

Sounds like your aren't in debt because of overspending, but because of unfortunate circumstances. I've seen many friends consolidate loans only to continue to keep paying the minimum payment. But you don't seem to have the baggage of bad habits.

In their mind their consolidated debt is just like another utility - a fact of life. But you don't have that problem, which is great!

Consolidation will help reduce your interest rate; so, on a purely rational basis, it makes sense to do.

As for the rrsp contribution. You could consult this page:

http://www.taxtips.ca/calculator/cdncalculator.htm

If you enter your income in the calculator, and in "RRSP Deduction", you will find that you save about 2600 dollars in taxes. So, at the end of the day, you would have 6 more K in the RRSP (assuming you keep 2k for emergencies and bit extra for the gains tax?) and 2600 in tax refunds. If you used the refund to pay down the debt. I guess it would be a good idea.

Personally, I would take the entire 6k and throw it on the line of credit. This would help me focus all my intensity on the visa debt. But, as long as you place your intensity on the debt, I don't think either method will matter. Its just a matter of preference?

 

[Sampson]

Forget about RRSPs, tax refunds and everything else and focus on that VISA. You'll be hard-pressed even with the advantage of compounding and time to have returns exceed 19%.

With that income, assuming your rent is not outrageous, you really should be able to take care of your debt in a year or sooner if you keep your job. After the majority of your debt is paid down, revisit this question.

 

[investnoob]

Vej, another perspective is to look at things from the "Net Assets" angle. If you put 6k in the RRSP and put the refund towards your debt you will have increased your position, i.e. net assets, by 2600 over the alternative.

That is, you will now have an extra 6k in retirement savings, and have decreased your liabilities by 2600. In this point of view, what you have suggested makes a lot of sense because you have increased your net assets by 8600.

If you did as I suggested, and just used the 6k to wipe out the line of credit, you have really only improved your net assets by 6k.

I hope this makes sense. Of course, your RRSP is a tax liability, but only when you decide to withdraw funds, hopefully when your tax rate is lower.

Update Finally, you will get several recommendations for debt reduction. A good explanation of the three most common strategies (including consolidation) is explained here by Kathryn at million dollar journey: http://www.milliondollarjourney.com/paying-off-debt-lowest-balance-or-highest-interest-first.htm

I am advocating Strategy No. 2, Samspon is advocating Strategy No. 1 and you are looking at strategy no. 3. At the end of the day it is a personal decision that only you can make. I hope this helps!!!

 

[Four Pillars]

With the updated info I would say that loan consolidation is probably a good idea since it will lower the interest rate.

I'm not sure if it's better to put the $8500 into your rrsp or pay off the loan. Assuming you can consolidate all your loans into a reasonable rate then you might be better off with the rrsp. Either choice is a good one in my opinion.

 

[Vej]

Forget about RRSPs, tax refunds and everything else and focus on that VISA. You'll be hard-pressed even with the advantage of compounding and time to have returns exceed 19%.

With that income, assuming your rent is not outrageous, you really should be able to take care of your debt in a year or sooner if you keep your job. After the majority of your debt is paid down, revisit this question.

Hi Sampson!

This comes down to taking one year (for example) to pay a 16,000 Visa bill off at 19% versus taking maybe two years to pay off a consolidated loan at a rate of perhaps 7% plus a tax benefit (i'm in the highest tax bracket) from having put funds into an RRSP and a nest egg for a house down payment or retirement.

The risk is different for both options, but I think I benefit quicker and in the longer term I'm in a decent situation also.

I believe I have the discipline to stick to my plan. Do yo think this makes sense?


Thank you everyone for your responses! I'm finding this very beneficial!

 

[SavingMaster]

I would phone CIBC tomorrow and ask for a lower rate on that VISA -- because the one you have now is virtually criminal. That alone will save you a chunk of money/allow you to pay it off sooner.

 

[sprocket1200]

My mind can only grasp the simple things so this is what I see:

Income: 90K T4 plus $4250 cap gain (I assume 50% gain as the cost was not disclosed)

Expenses: $25,000 income tax (based on above income and BC)
32,570 debt
$30,000 living expenses including rent, car, etc.
Total exp: $87,570

So Total income and cash $98,500
less expenses 87,750

leaves $10,750.

Use this cash to buy RRSPs and put tax refund in emergency fun in TFSA.
When that RRSP 3.3% come up, transfer it and DCA it into long term investments.

From a cash flow perspective/ Why worry about taxes in August (except for sound planning). Throw that cash on the heavy interest loan (after figuring if you can do a credit card transfer to a lower rate). Then use all free cash flow to pay of next highest.

don't forget to talk to your employer about making sure your tax is the lowest it needs to be. you may be able to free up cash now, but make sure you are ready come April.

With this high of an income this problem is about time, NOT money. use the time wisely.

As for emergency fund? If you have LOC room available, there is no worry in the short term. ONce these debts are clear set it up as above.

For the coming year, save hard for RRSP and TFSA. start planning your future house and car purchase now. with that income you should never have to borrow for a car ever again (though you may want to for strategy reasons).

 

[Potato]

With that high interest VISA I'd suggest figuring out what your tax liability for selling your shares would be, set that aside*, and put everything else against the VISA. No point in keeping any aside for an emergency fund or RRSP contribution, not with that big a balance sucking 18%. Besides, you can always re-borrow it if another emergency crops up.

* - or, if you can save it later in the year, then put everything against the Visa ASAP and just be sure to save up before tax time.

With that kind of balance at that rate I wouldn't worry about investing right now, since you're very unlikely to do better in the market (and especially not in 3.3% GICs!). In fact if your tax rate was lower, I'd consider cashing out the RRSP you do have to whack that credit card.

Have you already asked the bank about a consolidation loan or an increase on your LoC? With your income, as long as your credit is otherwise decent you should be able to get a 20-30k LoC at that rate. Plus I'd be surprised if the bank looked favourably on keeping your money in an RRSP rather than paying back your debts, so I'm not sure that would help you get a consolidation loan (though it wouldn't be the first time I was baffled by the thought process of a lender).

What about an RRSP loan in Feb?

 

[Elbyron]

Given that you say you are able to budget responsibly, I'd say that the debt consolidation loan is definately a good idea, regardless what you do with the $8500. That VISA interest is terrible and the fastest way out of it is to get a consolidation loan.

As for the $8500, I like the RRSP idea but you should consider putting it to use sooner, by temporarily depositing it in the LoC account (either the existing one or the consildated one). Make sure you don't re-borrow this money until next February, at which time you can buy your RRSPs with it. Think of it as a sort of short-term investment except that you're saving interest rather than earning it.

I agree with sprocket that there's no need for an emergency fund as long as you leave room in your LoC. The money will do more good keeping your interest payments down than it will if put aside in a TFSA. You also have less need of emergency funds since you don't have a house to take care of, and because you have a lot of disposible income that could be re-allocated if needed in an emergency.

 

[Chigu]

Assuming you're in Ontario, you may want to contribute enough into your RRSP to get your taxable income below 81,452. So if you are making 90,000. You would want to contribute atleast $8,548 into your RRSP.

Marginal tax rate currently = 43.41%
Marginal tax rate (76,440 - 81,452) = 39.41%

You'll get a bigger refund!

 

[Vej]

Making progress...

Thanks to all who gave me advice and helped me reach a decision with my plan.

So far I have done the following:

Used my $8,500 and some extra cash I got from selling some sporting equipment to pay off all my Visa debt.
I'm utilizing the maximum capacity on my Line of credit as it is the cheapest option at 5.25% (the least of all evils in terms of debt).
I have refinanced my truck so now I'm paying 6.75% in interest instead of an outrages 8.5%

From here I plan to pay off my Line of Credit and when I have enough to pay off my auto loan I will use all my line of credit capacity once again to pay off my auto loan early. I will get refund for the insurance protection that I was forced to take.

By the end of tax year, I play to take an RRSP loan to maximize my tax return. I plan to pay that loan off aggressively too, and as soon as that is paid off, I'm hoping to put 50% of my wages into savings/investments.

I hope to be 100% free of consumer debt by April '10!

Thanks again for all the advice, you people really helped my work out my strategy and motivated me. Cheers!

And as always, I'm happy to here feedback on what I ended up doing...

 

[The Financial Blogger]

Your line of credit is at a good rate and you probably won't get a better rate through a consolidation loan.

Hence here's what I would do:

#1 Take money from the 8.5K to pay off the line of credit (this will reduce your debt servicing ratio when applying for your conso loan)

#2 Apply to consolidate your car loan along with credit cards.

#3 Once your loan is disbursed, take the money from your line of credit and invest the full 8.5K in RRSP to get tax deduction in 2010.

#4 set an automatic payment from your bank account to your line of credit as it was a loan.

By doing so, you will increase your chances of getting approved for your consolidation loan, pay off your debts faster with reduced rate and benefit from your RRSP tax return :-D

disclaimer: I work in a bank ;-D

 

[Sampson]

Used my $8,500 and some extra cash I got from selling some sporting equipment to pay off all my Visa debt.....

I hope to be 100% free of consumer debt by April '10!

Good for you Vej! Way to pay down debt

Although some may argue that this was not the 'optimal' thing to do, its seems you're young, have great earning potential, and I'm sure you'll find that if you can keep a high savings rate, that 6 months of not investing in the RRSP won't make one bit of difference.

If I were you, I'd start talking to your banker(s) about that RRSP loan. Since you've tackled the credit card and plan to tackle the auto loan aggressively - some will probably be very willing to start lending you money for the RRSP. Next step - how and what to invest in.

Good luck!

 

[Vej]

Good for you Vej! Way to pay down debt

If I were you, I'd start talking to your banker(s) about that RRSP loan. Since you've tackled the credit card and plan to tackle the auto loan aggressively - some will probably be very willing to start lending you money for the RRSP. Next step - how and what to invest in.

Good luck!

Thanks Sampson!

With regard to the RRSP loan. I plan to wait until the rrsp deadline to put the RRSP loan in place. The RRSP's will gain interest, but I will always pay more interest on the money have borrowed, so doing it sooner rather than at the last minute will just put more of my money in my banks coffers. Don't you think?

-Jev