This is a game much more serious when a lender has a mortgage on your house as security.
Maroney on Money for August 17, 1997
I don’t know why, but lately it seems I’m being inundated with offers of money. Rarely a week goes by where I don’t open my mailbox to find a letter, brochure or a handbill from some organization offering to lend me money.
Usually, the biggest decision I make is whether this information belongs in the newspaper recycling bin, the cardboard recycling bag or simply in my round filing cabinet.
My latest letter states that I “have an asset that may be lying dormant”. Given that the asset being referred to is my house, I don’t find its inactivity particularly bothersome. In fact, I prefer that it remains inactive for at least as long as I reside there.
Typically, these deals are offered to homeowners since they most often involve pledging home equity in return for cash. Although the cash received can be used for any purpose the borrower may choose, my letter suggests consolidating debt into one low monthly payment.
The example contained in my letter involves an individual (“good customer”) with $65,000 of equity in his house. Evidently, Mr. Good Customer has also been a good consumer since he has managed to rack up $14,520 in debt on his six credit cards leaving him with a monthly payment of $647.
The deal being offered will provide Mr. Customer with $14,520 to pay off his credit card debts plus additional cash of $10,000 if, and when, he wants it simply by writing a cheque. Considering Mr. Customer’s track record, the odds are that he will be “wanting” this extra cash, and soon.
By accepting the offer, Mr. Customer will reduce his monthly debt financing cost from $647 to $181.50 per month. Sounds like a good deal but is it really?
Since no interest rate was provided, I ran the numbers on an amortization program and I see that the interest rate being charged on the loan works out nominally to 15% per year. Now we all know that certain credit card rates border on usurious, but an interest rate of 15% per annum is certainly nothing to write home about.
Since the loan being discussed here is really nothing more than a second mortgage, Mr. Customer has converted a number of unsecured loans into a single secured loan. After all is said and done, the fact remains that Mr. Customer still owes $14,520.
In summary, Mr. Customer pledged the equity he had in his house in return for a reduction in his monthly debt financing costs albeit at an interest rate that is still very high at today’s rates.
This may not be a bad thing depending on Mr. Customer’s future conduct. Is Mr. Customer going to be diligent and apply his monthly saving of $465.50 against the loan balance outstanding? Or will Mr. Customer carry on merrily using his six credit cards and his $10,000 of additional borrowing capacity to grow into his monthly saving? Mr. Customer’s history suggests that the latter is the most likely occurrence. If this turns out to be the case, Mr. Customer will find the game much more serious now that the lender has a mortgage on his house as security.
Debt consolidation can make a lot of sense, however, be careful. Simply consolidating debt to free up cash flow to allow even more uncontrolled spending is taking a ride on the slippery slope to bankruptcy. And if you’re considering debt consolidation, say “no” to the additional cash many of these lenders will offer. To do otherwise is asinine in the extreme.
Jim Maroney is a chartered accountant with Andrews, Brown, Maroney in Maple Ridge.
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