This month’s commentary will focus on something that many of us have but very few of us like to talk about. I’m talking about that evil word debt. More specifically, Lines of Credit (LOC).
A LOC can be an effective tool when used properly. When abused, it can be the beginning of a financial disaster and meltdown of your net worth. Lending institutions promote Lines of Credit as a tool that gives you what you want today, flexibility, and peace of mind. In my opinion, a LOC is a roadway to lifelong debt, fluctuating interest rates, and if mismanaged, a tool that can cause more harm than good.
When I was putting together this commentary I typed in “what is the purpose of a Line of Credit” into the Google search and here is what I found at www.ehow.com. “A line of credit is a ready source of funds from a bank or lending institution. It can be used for a variety of purposes, including unplanned expenses, family vacations, auto repairs and college tuition”. I didn’t see anything in that explanation that says it can be used for day to day living expenses, a replacement of your mortgage or used continuously to consolidate consumer debit. That being said, whenever you talk to a lending officer these days they will tell you that the purpose of the LOC is for you to decide. The previous rational may appear reasonable but is the advice in your best interest or that of the lender?
Sure, we are all in need of some financial resources in an unplanned emergency or short term need but, the financial community has positioned this debt instrument as a household staple along with your bank accounts and credit cards. Many institutions are now encouraging consumers use Lines of Credit in place of traditional mortgages. We are told it creates flexibility, convenience and we only need pay the interest if we want to.
I could go on and on about how we abuse this financial instrument and how those that provide it to us tell us it is good for us but I will refrain from a long rant and just ask you to consider the following:
There is never an end date to paying off the line of credit if you keep using it.
Interest rates are not guaranteed and you could be forced to pay more interest.
If you can’t pay your current expenses now and you use your line of credit, what will be different next month where you can’t pay your expenses plus now you need to pay off or down your line of credit?
Two of Canada’s largest banks just reported record quarterly earnings. If you read further into their reports they admit that they are earning less money from the interest spreads on lending but they are able to increase their profitability by lending more money to you and me. If you take on more debt is that really in your best interest in accumulating wealth? The short answer is NO. The simple consistent formula to creating wealth is to increase investments, pay down debt and reduce taxes.
If you have a Line of Credit and you owe more than $25,000 then perhaps there is a better way. Give us a call and let’s review your options.