Collaborate before clients consolidate debt

Often, clients consolidate debt when they’re feeling pressure from too many payments and varying interest rates. Many of those interest rates can be quite high if most of the debt is unsecured or consumer debt, so they usually jump at the first solution and make all their decisions based on the single monthly payment on the consolidation loan, versus how the old payments added up. What they often fail to consider is the interest rate, any fees or restrictions and if there are any other consolidation options.

This combination of feeling they must hurry to get the problem solved and their lack of knowledge about options can get clients in big trouble. I’ve seen many smart people assume the solution they’re offered is their only choice. And I’ve heard some clients say they “felt lucky” the bank gave them the loan.

Lucky? It’s a business. The client was given the loan because he qualified, not because the loan officer liked him. Advisors must help clients realize their own power when it comes to their personal finances. Give them the power to question if they’re looking at the most cost-effective options or not — even when they’re applying to borrow money.

For some reason, people tend not to want to rock the boat when they borrow — as if asking too many questions will cause the loan to be rejected. It’s not so, and such beliefs can put your clients in jeopardy.

A few years ago I met with a couple, call them Sarah and Jack. Sarah was a nurse and Jack a police officer. They had good incomes, a nice home and even had some decent retirement savings for their age group. However, they couldn’t seem to get to the end of the month before they got to the end of the money. And they were no longer investing regularly.

They were in their mid 40s, had two young sons to put through university or college and hopes of retiring at 60. None of these goals was unreasonable if they got rid of their debt, had a savings cushion and could get back to regular monthly investing.

But when I looked where their money was going, I discovered they’d made a shocking mistake. Just two years prior they’d racked up a series of credit cards with interest rates ranging from 19% to 28.9%. Further, they had a line of credit they kept maxing out. But it was a deferred-payment furniture purchase that pushed them over the edge — they’d missed paying it off before the interest-free period ended and $6,500 worth of furniture quickly rose to $8,700 as the interest was added on retroactively.

To top it off, they intended to pay the suggested $200 monthly payment the finance company was asking for. If they’d followed through with this plan, they would repay a total of $25,000 for $6,500 worth of furniture. Feeling they were out of options, they went to their bank and asked for advice. They were told consolidating the then $40,000 of debt they had amassed was the way to go.

Upon hearing they could reduce the current required monthly payments on their many debts from $1,580 a month to bi-weekly payments of $550, Sarah and Jack were so relieved they signed on the spot. I’m sure the banker went over this, but they didn’t seem to realize it until I combed through the loan documents some two years later, they were paying 10% interest. As well, there was a $63 monthly insurance premium.

What you don’t yet know is that Sarah and Jack owned a home worth about $280,000 with a mortgage of $135,000. So their five-year consolidation loan was actually costing more in a month than their mortgage payments. And because they didn’t address the financial behaviors that got them in trouble in the first place, their habits didn’t change. When I got a hold of them, they were only two years into the consolidation and had already racked up another $23,000 on those credit cards and line of credit.

So that mere $388 a month the consolidation had saved them was more than eaten up by the cost of new debt obligations. Lost cause, right? Wrong! They, like the rest of us, are always a work in progress and today they’re on the right track.

First, I referred them to a colleague to refinance the whole lot. They combined everything — about $173,000 at that point — and provided them a mortgage of that amount. Their payments went from a total of $2,800 monthly to $1,200, and their mortgage will still be paid off in the 15 year planned timeframe.

With the other $1,600 a month they’d grown accustomed to paying out, we did three things. We took $400 right off the top — as this was money they were overspending every month.

That left a true surplus of $1,200 monthly. We set up short-term savings of $600 a month for variable costs like haircuts and emergencies. When this short-term account reaches $20,000, they’ll top off long-term savings with any excess once a year. The remaining $600 went into long-term investments. They also went on a cash allowance for their discretionary spending (no more cash, no more spending) and they do a very good job of keeping each other on track.

Without intervention, Sarah and Jack were on track to need a new consolidation loan every five years. They were on the hamster wheel of debt. Had I met them before they took out that first loan, I could have done even more for them but their advisor at that time didn’t worry about the other side of their balance sheet and was in the dark about their debts.

He did notice when they cancelled all their monthly contributions and some insurance policies, but by then it was too late. And it’s too bad, because he could have been there for them, if only he’d discussed the fact that major financing decisions can affect an entire plan and had the expertise to help them work through debt issues.

Unfortunately, this isn’t a common area of expertise. To my knowledge, there are no real programs or training concentrating on debt management. But this remains a major issue that underpins what’s led to the condition of our economy and our financial services industry. Yes, we in Canada are in much better shape than our counterparts in the United States, but better than abysmal is not an accomplishment. We need to do better; and we will.

Even though advisors can’t sell mortgage or debt products — unless you’re a mortgage broker too — we’d better know how these products work and how they affect our clients, because one day those decisions, especially those around consolidation, could come back and bite us and our clients right in their assets.

Stephanie Holmes-Winton is a Halifax-based financial advisor.