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Case Study: Financial Priorities

Miya wrote me an email about her financial situation and was looking for an opinion.

I am a big fan of Million Dollar Journey and I learned a lot from here. I realized that if you don’t manage money, the money will manage you.  Although I understand the fundamentals about finance management (I think I do), I’m still in a dilemma of choosing my priority between paying off debt, contribute to an RRSP or build a portfolio.

The Numbers:

  1. I am married with a new born baby. Annual income of household is $75,000 before tax ($60k take home in BC).
  2. Annual expense budget which is quite practical is about $50,000 (Include: rent, car loan, cell phone, groceries, baby expense, credit card minimum payment, entertainment, etc.)
  3. Total credit card and line of credit: $45,000 (between 15-19.5% interest)  note: from wedding expenses and over spending before baby was born
  4. Cash: $10,000
  5. RRSP: $15,000
  6. RESP: none

Our household after-tax income can basically cover the expenses. For the cash and other extra income, I don’t want to put them all against my debt, instead I would like to contribute to our RRSP or invest into stock market which I think is a good time to build a portfolio. I know it is crazy but I would like to see some rewards rather than fill the big debt hole.

I appreciate your advice.

So the question is, what does Miya do with their cash?  To be blunt, it is crazy to consider investing in the market while holding credit card debt, especially when it’s upwards of almost 20%.

I think the biggest issue is that a lot of people feel that investing is sexier than paying down debt.  The reason being is that investing can be more exciting and has the opportunity to grow your money, while paying down debt doesn’t have the same type of gratification.

There are times when I believe that investing should come before paying down debt.  For example if the interest rates are extremely low, or if it’s a tax deductible loan (good debt).  However, in Miya’s case, the debt is extremely high interest which would be extremely challenging to beat by putting the money in the market.

If the cash was invested in a non registered account, the market gains would have to be greater than 21% before tax to match the 18% debt on the credit cards.  As paying down the high interest debt is a guaranteed return, the risk adjusted return required from investing would have to be even higher.

My suggestions?  I’m not a financial advisor, but if it were me, I would:

  1. Take the cash savings and pay down the credit card debt (highest rate first) as soon as possible.
  2. Tighten that budget to squeeze every dollar possible to pay down debt.
  3. Consider pausing RRSP contributions (unless it’s employer matched) to put more towards the debt.
  4. After debt is repaid, invest by contributing to your RRSP or TFSA.

This scenario is similar to Paul and Melanie’s, but they’ve already paid down more than half their debt in 6 months since the post!

Those are my thoughts, what do you think?

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 53 comments… add one }
  • Four Pillars July 29, 2009, 9:04 am

    I couldn’t agree more with your advice.

    I noticed that “RESP” has been added as one of the possibilities (I’m assuming) – I would suggest that they don’t worry about that for at least a few years.

  • Kathryn July 29, 2009, 9:38 am

    I agree that the #1 priority needs to be to pay down the 19.5% credit card debt.

    I would leave $1000 in cash for emergencies.

    Is the 60K take home post baby? Does it include Miya’s maternity leave pay / EI, etc or are these figures pre-baby and reduced even more since the baby came along?

  • Al July 29, 2009, 9:48 am

    If the 60K after tax includes EI benefits that will expire and not be replaced by Miya going back to work, then it’s time to move quickly on paying down debt and re-evaluating the expenses.

    If the 60K is a low point for income, then still pay off the debt before considering investment. My gut is the markets are overvalued.

  • Michael - Fat Loss Tips July 29, 2009, 10:00 am

    Absolutely the right thing to do but emergency cash is also important given we don’t know here EI situation and the unexpected costs of a new born.

    Good comment about the sexiness of investments vs. cash and good debt vs. bad debt.

  • Tax Guy July 29, 2009, 10:17 am

    My suggestion is a little different:

    1> Create a realistic budget and prepare a net worth statement. This provides an accurate picture of your current situation.
    2> Set a goal to increase net worth by x% this year. Net worth planning transcends debt reduction and can be done every year. It will also help you set additional goals such as home ownership, education planning.
    3> Make sure you have an emergency fund. If using the cash to pay of debt means there are no accessible emergent funds, then do not use it for debt reduction – put it in a money market fund instead and look for other ways to reduce debt.
    4> If you can make ends meet then divert funds to debt reduction.

    Then insert MDJ #3 & #4 here.

  • cannon_fodder July 29, 2009, 10:35 am

    If you want to see rewards, then there is a simple 3 step plan.

    First – pay down the debt.
    Second – pay down the debt.
    Third – pay down the debt.

    Don’t worry about leaving any emergency savings – an untapped LOC will be more financially prudent than having a $3k sitting in a bank account at 0.25% interest while there is still $3k in a LOC at 15%. (How in the heck can someone get away with charging 15% on a LOC?

    There is no guaranteed way to receive an after tax return anywhere close to 15% except by paying down the debt.

    Paying the minimum credit card balance?! That is NOT a practical monthly budget – that is a recipe for financial disaster which has, for many couples, led to marital breakup.

    Let’s imagine that you have a $3,000 credit card bill and it is at 19.5% annually. The minimum payment is going to be around 2% most likely. Let’s imagine that you decide to pay down $60 every month or 2% of the original balance as opposed to keeping it at 2% of the outstanding balance (which would mean you put less $ towards it each month). Let’s also assume that you don’t charge anything else to your credit card until it is paid off. Well, you will be waiting about 8 1/2 YEARS!!! Oh, and it only cost you just over double to pay it off. Does that sound like a practical budget?

    Some people need a soft nudge in the right direction – based on what you have stated, I don’t think that will work here. You admit to being a “big fan”, and you “learned a lot”, that you “understand the fundamentals about finance management”, but in spite all of that you say that “it is crazy but I want to see some rewards” rather than put all of your cash and other income against “that big debt hole”.

    I’m not sure how you measure your understanding or how much you’ve learned but I suggest rereading everything to do with debt on this and other blogs. Don’t forget to catch an episode of “Til Debt Do Us Part” if you have it (I believe it is on the W channel).

    This isn’t my blog so I don’t have to be nice…

    If you embark on any other course than singlemindedly paying down that debt, then I would suggest you weren’t really coming here with an open mind – you just wanted someone to tell you what you wanted to hear. To be absolutely blunt – if that is the case, then don’t bother coming back to this or any other blog until you are ready to think with your head.

  • Steve July 29, 2009, 10:50 am

    ^ Cannon Fodder mentioned “Till Debt Do Us Part”… all the episodes are available online at slice.ca… while I wouldn’t be quite as blunt as he would, I do think the original poster could use a good dose of Gail’s common sense…

  • geekmom July 29, 2009, 11:41 am

    I third the suggestion of going on a Till Debt Do Us Part marathon. You can watch all the episodes online at slice.ca and they are truly helpful and inspiring. My family has started a financial journey this year of waking up, smelling the coffee and paying off a lot of consumer debt. When we started out, we didn’t have any emergency fund to speak of so we have had to divert some of our available funds toward building that up; Miya is in a much better position as a result of having that safety net.

    I suggest beginning a daily routine of reading lots and lots of personal finance blogs to learn some ideas about cutting back expenses and living frugally. The Simple Dollar, Get Rich Slowly, Frugal Dad and Man vs. Debt are all good starting points (you can google these to find the websites). I have these blogs all loaded into my google reader alongside Gail Vaz-Oxlade’s blog and my routine is to sit and read the new posts each morning while eating breakfast.

    Miya, I urge you to work on transforming your opinions about debt. Get angry. See it as the shackle that it is, preventing you from getting ahead with your goals in life and making the future you want for your child. With that much consumer debt you must have minimum payments of around $1000/mo if not more. Think what you could do with that money! I could kick myself a million times over for being so stupid as to allow my family’s consumer debt to pile up so badly as it has. Instead, I’m working on kicking that debt out the door and making sure I build some new habits for the future.

  • Victor July 29, 2009, 11:43 am

    Pay down the debt. Don’t even think about investing. As others have said, you will not get 19% return anywhere! Save your RSP contribution room until you are on your feet financially, which right now you are clearly not.

    Take a look at your budget too. $50k per year in spending may seem ‘quite practical’ to you, but I assure you you can do better. Get a second opinion. Have someone else look at your expenses from an objective point of view. Get rid of your frivolous spending (eating out, cable TV, new clothes, etc.) until your credit card debt is gone.

    Sounds harsh? Maybe. But the alternative is to picture the situation you’d be in if the single earner in the family lost his job right now.

  • Victor July 29, 2009, 11:50 am

    Another great example of why blowing a ton of cash you don’t have on a wedding is such a BAD first step on a couple’s financial road together.

    I’m hoping to see a real decline in my lifetime in the ridiculous modern white-wedding fantasy that is instilled (let’s be fair) mostly in girls, causing many to prioritize a one-night bash and debt over a down payment on a house. Pure lunacy. I would love to see the wedding industry crash and burn.

    I’m not against weddings or marriage in general, just the overblown glitz and glamour surrounding many modern weddings, and the registries for couples that have been living together for 3 years already. Fancy china that you wouldn’t buy yourself with your own money, but you expect your friends to buy for you? Give me a break.

    Of the dozen or so weddings I’ve been to in my life, by far the most memorable were small, intimate affairs taking place in non-traditional settings (one was the family farm).

    Well that was a bit off topic. Apologies for the rant…

  • Astin July 29, 2009, 12:02 pm

    Just another voice in the “pay the debt” chorus here. Taking -20% to 0% is the same as taking 0% to 20%.

    $50k/year doesn’t seem very practical either on $60k take-home and $45k in credit card debt.

    Babies are pricey, but maybe some hand-me-downs or second hand stores might be worth investigating here. Not sure what “entertainment” includes, but there’s probably room for trimming there too. Of course, paying the minimum on $45k of credit debt every month is nearly as good as flushing money slowly away.

    Investing will yield no returns in comparison to the debt.

  • YYC27 July 29, 2009, 12:11 pm

    No brainer. Don’t even THINK about investing until you’ve paid off that credit card debt. It’s lunacy to think you’re going to be better off keeping that 19.5% debt intact.

    I hope the 15%-19.5% range doesn’t include the line of credit. If it does, get a new line of credit and burn the one that’s currently raping you.

    I agree with cannon fodder that I’d rather see someone pay down more debt than keep an emergency fund. If you need to tap into emergency funds, re-advance the credit. At least you saved on interest during until then.

  • Dave July 29, 2009, 12:50 pm

    Call me crazy, but in terms of a single-year net worth impact, investing in an RRSP and then using the tax refund to pay off credit card debt will have a larger impact…I agree that credit card debt includes very high interest rates, so assuming a base 10k to invest, why not:

    1. Put the 10k toward paying down credit card debt immediately
    2. Take out a 10k RRSP (or other) loan at the end of the tax year
    3. Make a 10k RRSP contribution
    4. Use the tax refund from the contribution to pay down more credit card debt

    That way you’ll get your RRSP contribution, pay down some credit card debt, and convert some of the high-interest rate debt to a lower rate…Just my 2 cents.

  • Qubikal July 29, 2009, 1:24 pm

    We should probably encourage the OP in this way…

    Putting money down towards a 20% debt is a guaranteed investment of 28% before tax (assume marginal tax rate of 30%, 20%/(1 – 30%)).

    Doesn’t an investment of guaranteed 28% rate of return before tax sound sexy enough?

  • Nick July 29, 2009, 1:43 pm

    @ Dave #13

    “2. Take out a 10k RRSP (or other) loan at the end of the tax year”

    They’re trying to reduce debt, not accumulate it. I would strongly sugggest Miya not do this.

  • JJ July 29, 2009, 1:52 pm

    Congratulations on starting to think about your financial priorities. You cannot start anywhere but where you currently are. You definitely need a repayment plan before your investment plan. If your debt was not so huge, then perhaps a balanced plan to pay down the debt at the same time as saving for the future.

    I would also recommend that you read The Automatic Millionare by David Bach. Check it out of your local library. It gives a lot of practical tips on all areas of finance and is an easy read. You can also visit his website to read other people’s comments about how they have turned their life around financially.

    I am cheering for you. You can do it. Baby steps, one at a time.

  • Elbyron July 29, 2009, 2:01 pm

    I think Miya needs to change how she views debt. She’s got this viewpoint that her outstanding debt is a gigantic hole that sucks in money, and throwing more money into the hole seems like a waste. So she wants to start building a small pile next to the hole because seeing the pile get bigger gives her a warm feeling of accomplishment rather than seing the hole get filled in. The problem is that the hole is growing deeper far faster than that pile will grow upward. The pile will soon be undermined by the growing hole, as debt increases and Miya is forced to liquidate her investments to pay collectors. The sooner she can repair that hole and establish a firm support for her pile, the sooner she can start accumulating that pile.
    I also agree with cannon_fodder and others that Miya should not keep any emergency funds that could be used to pay down debt, since there is already a LOC established that could be used in an emergency.

  • Dave July 29, 2009, 2:17 pm

    @ Nick #15

    “They’re trying to reduce debt, not accumulate it. I would strongly sugggest Miya not do this.”

    I agree that they want to reduce their debt, but debt consolidation is one way to do that. Effectively, they would replace 10k of their credit card debt with an RRSP loan, then use the proceeds of that loan to further reduce the balance on a credit card.

    If your only goal is to reduce credit card debt, then is is less effective than putting 10k toward your credit cards. If you’re looking to increase your net worth, however, it might be something to consider, as the immediate returns on the RRSP investment (the tax refund) are on the order of 15-25%, depending on your taxation rate, and this is on top of anything you earn from the RRSP investment itself. I’ll admit it’s also not quite as simple as just paying off your cards.

  • cannon_fodder July 29, 2009, 2:20 pm

    Dave,

    You aren’t crazy and it is good to see a creative way to approach this. Personally, and I’m probably not alone in this, an improved networth doesn’t buy you a cup of coffee – disposable income does. So, if I have an extra $10k in RRSP’s vs. a reduction in debt of $10k your perspective would say that they are equal since the impact to Net Worth is the same.

    I would say that while the impact to Net Worth might be the same (because if I take out the $10k in RRSP I incur a tax hit thus reducing my effective change to Net Worth) you might counter that the original tax refund will counter that. But, if investing in the RRSP is the preferred method, then why take the tax refund and apply it to the debt – shouldn’t it be reinvested into the RRSP? Or, better yet, top up the RRSP contribution even higher so that the tax refund pays for the additional contribution and your RRSP loan will then equal your RRSP contribution.

    Regardless you’ve added more debt to this situation – at a lower rate most likely but still you’ve added more debt. If a person needed help to cut down drinking you wouldn’t tell them to drink more but just go for the light beer sometimes.

    Now, if you could get a $10,000 RRSP Loan on a 1 year term at (insert whatever percentage you want, e.g. 4%) your monthly payments would be greater than the gap between their take home pay and their budget. That means the $35,000 debt would grow unfettered by 15-19% in that year which is significantly greater than the tax refund even if in the highest marginal tax bracket. That doesn’t look like a good way to increase the networth, nor eliminate debt.

    Please also keep in mind that it is likely that the LOC is compounded monthly. Thus, the effective interest rate is a bit higher than you might think at first glance. CC’s (if they are like mine) have a complicated interest calculation based on statement dates and purchase dates but they don’t charge interest on the interest. If it shows you an annual rate and a daily rate it likely will be that the annual rate is 365 x the daily rate as opposed to (1+daily rate)^365 which would mean it is compounded daily and thus much higher.

  • cannon_fodder July 29, 2009, 2:31 pm

    Dave,

    I think you’ve confused yourself (or at least us). You are not replacing credit card debt with an RRSP loan, you are adding debt.

    1st step – take the $10,000 cash and put it against the debt. CHECK (pretty much everyone agrees with this although some would say to keep some $ back for an emergency fund).
    2nd step – take out an RRSP loan of $10,000. Total debt is now $45,000 right where they started.
    3rd step – Contribute to RRSP.
    4th step – apply tax refund, let’s say $3,500, to CC/LOC debt. Total debt is now $41,500.

    That is now $6,500 more in debt than if they didn’t take out the RRSP loan. As posted above, their cash flow can’t handle the additional RRSP loan (while most experts agree you should take out an RRSP loan with a term of only 1 year or don’t bother, I think banks will let you go for 2 maybe even 3 years).

    On the other hand, if the rest of us were saying the following, THEN you would be quite right in saying this replaces some of the debt with lower interest debt:

    1st step – take the $10,000 cash and contribute it to the RRSP.
    2nd step – apply tax refund, let’s say $3,500, to CC/LOC debt. Total debt is now $41,500 all of the high interest variety.

  • Dave July 29, 2009, 2:49 pm

    cannon_fodder,

    Thanks for the input — perhaps I haven’t worded my suggestion clearly enough, so I’ll work with your numbers. Let’s assume that we are only dealing with 45k of Credit Card debt at 19.5% to be pessimistic, 10k of cash, and that the RRSP loan is at 10%.

    Before any action:
    45k debt at 19%
    10k cash
    Net: -35k

    Situation 1: After my suggested actions:
    35k debt at 19%
    6.5k debt at 10%
    10k RRSP invested
    Net: -31.5k

    Situation 2: After RRSP contribution only
    41.5k at 19%
    10k RRSP invested
    Net: -31.5k

    Situation 3: Pay off CC debt:
    35k at 19%
    Net: -35k

    You make a very good point in saying that taking out an RRSP loan has an impact on cash flow, but the consideration is whether or not that impact is compensated for by the lower interest rate.

    As far as emergency funds and other uses for the money are considered, this strategy is scalable, so the benefits to be weighed apply for any amount, unless the RRSP contribution would place the contributor in a lower tax bracket.

    Sorry if I’ve confused anyone — simplicity is certainly one great reason for putting the money directly toward credit card debt :)

  • cannon_fodder July 29, 2009, 3:01 pm

    Dave,

    Just ran the numbers very quickly and it passes the smell test. Two scenarios:

    1. Do as you suggested but I’ve put a more reasonable 4% for the RRSP loan and given them 2 years to pay it off. Take all of the $10k annual disposable income and partition it between RRSP loan and CC/LOC debt. This allows some money to be put towards the CC debt. It still grows but at least it isn’t spiralling out of control. In 2 years when the RRSP loan is paid off, plow everything at the CC/LOC debt. I’ve used 19.5% effective annual rate for this. I’ve also used an 8% growth rate for the RRSP and a 35% MTR. After 8 years they are debt free with about $19k in their RRSP.

    2. Instead, take the cash and pay down the CC debt and then plow the $10k disposable income towards the debt until it is paid off. Then take that money that was previously targetted towards debt reduction and invest it (RRSP’s, non-registered, RESP’s, whatever). The debt is paid of in a little over 6 years. We then have, over the next several months until we hit the 8 years from scenario 1, over $20k in contributions to our investments. I haven’t even taken into account growth in those investments nor tax refunds.

    For the long term, it looks like just paying down the debt with unbridled (get the pun newlyweds) enthusiasm takes the cake (again, the wedding puns!).

  • Dave July 29, 2009, 3:18 pm

    cannon_fodder,

    Thanks for running the numbers! 1. and 2. are showing exactly what I was going to point out next, particularly that my strategy would involve taking longer to pay off the debt.

    The only part that I would amend would be the fact that at the end of the first 2 years, you are once again left with the same decision, and if you are following what I suggested, you’d take out another RRSP loan for 10k, repeating every 2 years.

    Repeating the strategy would mean taking even longer to pay off the CC debt, but seeing a gradual increase in assets.

    I’m basing this on the marginal tax rate being much higher than credit card debt, but the ideal situation would really be to consolidate all of the 19.5% CC debt at a lower rate and then make your decisions.

    That said, I’m not changing my cards once I’ve played them, so I will concede! High-interest debt is not great for sleeping at night, and convoluted solutions to financial problems can also have adverse effects. Pay off that debt! Great discussion!

  • Rob M July 29, 2009, 3:31 pm

    KISS (Keep it simple s….):

    Step 1: take the 10k and pay off the debt, preferably the highest interest debt, but if you need an amount for an emergency fund then pay off some of the LOC (so you can easily get access to it) and the rest on the highest credit card debt.

    Step 2: Make the minimum payments against your lowest interest debts, and the largest payment against your highest interest debts. Make sure your total debt payments is at least as high (if not higher) than what you were paying before the balloon payment in step 1.

    Step 3: Increase your debt payments as much as you comfortably can (if it isn’t comfortable, you probably won’t keep it up, and slip back to your old ways).

    Step 4: Rest easy, knowing that you are making a MUCH better rate of return on your money than you ever could in the market.

    When the debt is paid off go to step 5.

    Step 5. Invest your money in something “sexier” like the stock market, but be prepared for the rides, and know that getting a 20% return is never going to be as easy as it was when you were paying off your debt.

  • Victor July 29, 2009, 3:34 pm

    Interesting! I don’t think I’ve *ever* seen such a strong consensus on a topic on this blog. I’d be interested to know if the reader takes the advice or ignores it.

  • InstruMike July 29, 2009, 3:37 pm

    I agree that paying down your debt first and looking at paying down debt is an investment in your future. The mind-set of establishing an investment portfolio before debt reduction (with a high interest rate) will hurt you financially in the long-term. Miya, you need to change the way you look at financial planning. Paying down debt is an investment in your future.

    Also, I’m surprised no one has mentioned anything about reducing the interest rate on her debt. In today’s low-interest environment she should be able to do something about that high 15 -19.5% rate. Call the lenders and ask for an interest rate reduction. If they don’t give it to you, look into balance transfers, but be careful of fees. Some CC’s charge a 3% transfer fee. Some transfers aren’t worth it, while others can make a big difference in the interest you pay and the length of time needed to pay it off. Try other CC’s or a bank loan. Before you make your decision, ask what the monthly payments are. Minimum monthly payments vary between CC’s and in my experience some are 1% and others as high as 3%. Make sure it fits into your budget. And pay down the highest interest rate debt first.

    You say you are looking for a reward. Your reward will be watching that debt shrink faster and faster. Think of the monthly interest you pay to hold that much debt. It must be in the order of $600. Once its gone you will feel the reward of being free from the financial burden of carrying high interest consumer debt.

  • Tucker Wright July 29, 2009, 3:52 pm

    Hammer the debt. Debt should always be the first response when looking to allocate money in any fashion.

    If associating yourself in the market is necessary for peace of mind ( wich it shouldn’t be) consider a quick loan or leverage loan. Something small say 10-15,000 and depending on age allocate that money accordinly.

    Prime +1% 0r 2% is out there and half of the contributions are tax debuctible. $10,000 in some cases right now could end up costing you somewhere between $12-20 / month after taxes.

    I unfortionatley took out a $45,000 quick loan at the peak of the market costing me $215/month before tax deducation and it has taught me many lessons, mainly that the market is way too volitile to randomly take part in but since the down turn my monthly payments have goten as low as $90/month befoer tax deduction and now i’m making money back quickly..

    Current portfolio @ $39,850 and got as low as $28,500 around christmas.

    high’s and lows!

  • FT FrugalTrader July 29, 2009, 3:52 pm

    Thanks for running numbers Cannon – great ideas guys.

    InstruMike, ah yes, that is another great idea and something that I neglected to mention. Balance transfer some of the higher credit card debt to lower interest rate products.

  • cannon_fodder July 29, 2009, 4:20 pm

    Dave,

    So you want to play it like that, huh? ;-)

    Well, let’s take the idea we’ve both been talking about except this time when I pay of the CC/LOC I put the unneeded payments into a TFSA earning the same 8% rate as the RRSP. In the other scenario I will, upon paying off the RRSP loan, borrow another $10,000, apply the tax refund and rinse, repeat.

    If we stop after 8 years we would have:

    Almost $60k in the RRSP and about $34k in CC/LOC debt (networth +$26k)

    or

    about $21k in the TFSA (networth +$21k).

    You might say networth is $5k better in the RRSP scenario. I say you show me how you can legally take $60k out of the RRSP all at once and pay no more than $5k in tax and I will quit my job and manage your career as a financial guru.

    Or put another way, I have my $21k in the TFSA and I decide to borrow $50k at RRSP loan rates (not CC/LOC rates of 15-19%), contribute to my woefully inadequate RRSP with all of that unused contribution room and get a sizeable (let’s say, about $16k) tax refund which I apply to the loan. I’ve got $21k in TFSA, $50k in RRSP’s and a $34k low interest loan. Networth: +$37k.

    As I said before, the CC/LOC debt never gets paid off unless we start counting on increases in income to put more money towards it. The size of the debt and its interest rate almost exactly matches the tax refund plus whatever is left over on a monthly basis that doesn’t go towards the RRSP loan.

    Ever seen a stationary bike? You sure work hard and long but you never leave the basement.

  • cannon_fodder July 29, 2009, 4:29 pm

    InstruMike,

    I mentioned in my first post that a LOC at or above 15% didn’t sound right. Either there was a typo, misunderstanding or Miya and family have a very poor credit history which will affect their chances of consolidating their loans at a more favourable rate.

    If they haven’t explored that option fully then it will be further testament to how well they understand finance management.

  • Dave July 29, 2009, 4:52 pm

    cannon_fodder,

    Whoa whoa, I never mentioned stationary bikes! I do like to adopt a net worth approach though, and if improving net worth means staying on a stationary credit card bike while the room around me improves, I’m all for it :)

    What I wanted to bring into the discussion is the fact that your marginal tax rate is usually much higher than your highest debt rate, and just because the cost is implicit (lost opportunity for return) doesn’t mean it doesn’t exist. I would favor the 60k RRSP + CC debt over the 21k TFSA just because of the growth opportunity available there. You could use the TFSA as an investing account as well, but I think the discussion is tending toward an “emergency fund vs. RRSP debate”, when we should be thinking about what is most rewarding for Miya.

    Miya stated she wanted to build some investments, so we have to assume that she doesn’t want to just pay down debt. Most of the posts are saying “pay it down, you’re wrong”. That advice ignores the behavioural side of finance for Miya, so maybe a hybrid approach is more appropriate.

    In my opinion, if she
    (1) Consolidates high-interest debt to a lower rate,
    (2) Makes an RRSP contribution, and
    (3) Makes some headway into paying down credit card debt,

    then she has reached her goal of starting a portfolio while increasing her net worth and reducing both her debt and cash flow constraints.

    The details on how much she should allocate to each step are personal preference, and I think she will be best positioned for that.

    Yours truly,

    The Phantom Biker

  • InstruMike July 29, 2009, 5:00 pm

    cannon_fodder

    15% for a LOC does sound very high.

    On another note, I was carrying a small balance on my Sears card (about $500) that I was intending on paying but kept putting it off. I have recently found out that the interest rate is 28%. I asked for a rate reduction and they bluntly refused even though I have an excellent credit history, a high FICO credit score and a good income. I gave them ……! for charging such a high rate especially in today’s low rate environment and immediately paid off the balance.

    It goes to show that some lenders will work with you while others are out to get you.

    P.S.
    Great stationary bike analogy. I just might use that.

  • Kathryn July 29, 2009, 5:57 pm

    Miya, you there?

    How are you feeling about all the advice / comments? Any idea where you’re going to go from here?

  • Chris July 29, 2009, 6:19 pm

    You should certainly pay off the high-interest debt first. This must be costing you hundreds per month in interest. To beat this by investing you’d have to be a pretty brilliant investor. If this were a mortgage I could see investing rather than paying down the debt, but at these rates there is no way it is a good idea to invest rather than pay down the debt.

    Also see if you can consolidate some debts on a lower interest line of credit to help you pay them off faster. Most of your cash should go straight to the debt. Get rid of it asap!

  • Ms Save Money July 29, 2009, 7:12 pm

    wow – I know everyone has said that interest is high – but gosh it is really high.

    The consensus here is that you need to pay off your debt otherwise it’s going to swallow you alive.

    But I also think you shouldn’t use your savings to pay the debt off though – instead try to budget your expenses and use your income to pay the debt off. Only reason I say not to use your savings is because you might need it for something important – you never know what what will happen. And also because the savings is what you pay yourself. Also, hold off on the putting your money into the RRSP.

  • Andrew July 29, 2009, 8:19 pm

    Great advice Frugal. Sometimes the best advice is not exactly what the person wants to hear, but I am glad you advised to pay down the debt.

  • adam July 29, 2009, 8:20 pm

    Wow listen to you guys go, Cannon & Dave. :)

    (Be careful dragging the TFSA into this arguement as everyone I know only has 5K room in their TFSA – at this point, when you start talking 21K in a TFSA, you’re generally talking 4 years out from now.)

    The BEST thing she can do right NOW is negotiate those interest rates down and start paying off the high interest debt first. Muddying the waters with RRSP loans and the like is making some serious assumptions about her level of discipline. Personally I don’t think she has enough to follow through with any plan like that. Long time horizons with slower results and more volatility.

    Just renegotiate your rates and start hammering the CC\LOC debts down aggressively.

    Adam

  • cannon_fodder July 29, 2009, 9:53 pm

    Adam,

    Don’t forget they are a couple. So $10,000 this year and another $10,000 in just about 5 months.

  • The Road to Meaning July 29, 2009, 10:33 pm

    Like many have already said, I believe paying off as much of the debt as fast as possible should be your main priority.

    You do not want to be in a bigger whole then you are already in. Investing can always come later. Nothing beats the peace of mind you receive once you are debt free.

    Good Luck!

  • Miya July 30, 2009, 3:29 am

    Hello everyone,

    I truly appreciate all of your advices and help. The reason I haven’t put my savings against debt is I have concerned about the current recession. Say if one person lost a job, it will be a tough situation. However, I would take half of my savings into LOC which I treat it as my emergency fund, another half I will pay off the credit card balance with the highest interest rate. BTW, if I paid LOC, will the lender reduce the limit? As it happened on my credit card already, PC financial just reduced my credit card limit from 5,000 to 4,000 after the balance is less than $4000.

    I understand that debt consolidation, balance transfer and ask lender to reduce the rate are good ideas. Unfortunately my credit score is just 620 and my credit cards are all maxed out. No bank or at least no big banks would approve a new LOC or offer me a lower rate at this point.

    I am very clear about my financial priority now and I will figure out an action plan with my husband. The successful stories from Million Dollar Journey and your comments have inspired me a lot. Again, I thank all of you from bottom of my heart. I will come to the site everyday to remind myself where I came from.

    Miya

  • cherilynn stone July 30, 2009, 4:42 am

    An absolute informative post!

  • Kirk S. July 30, 2009, 8:30 am

    Just to go the other way on this (to break the consensus).

    Of course it is ridiculous to have loans at 15-19% and not pay them off. But if she gets a $100 raise at work, I see nothing wrong with $75 (or a large percentage) going to repaying these debts and investing the other $25 (or a small percentage) in your RRSP.

    If every cent that you have goes to repaying bills, although it is the prudent thing to do, goes to repaying bills (reducing the negatives) it can be a bit depressing. We all like to increase our assets (increasing the positives). Although this will be a slower way to reduce her debt to zero, it probably will work a little better for her in reality.

    Just my two cents.

    • FT FrugalTrader July 30, 2009, 12:46 pm

      Kirk, my wife balances out the equation on the spending side of things. :)

      Adam, the pension is a public pension plan that my wife owns, not CPP.

  • adam July 30, 2009, 12:36 pm

    Kirk,

    From a net worth stand point, reducing the negative is, in fact, increasing the positive. It’s a moot point – fact is she won’t be able to find a net return exceeding 20% in the market YoY. By investing rather than reducing 19.5% interest on an existing debt, she will in fact be increasing her ‘negative’ further.

    Cannon, good point. I didn’t clue in that it was a couple… I try to keep my women unwed and at their own address – so I think singularly all the time ;)

  • Mark in Nepean July 30, 2009, 11:16 pm

    I agree with my friend Cannon_Fodder, with a twist:

    1) pay down high interest debt
    2) pay down high interest debt and
    3) pay down….well, you get the message.

    Although investing may appear sexy, so is not having any debt other than your mortgage. Not many people can say that!

    Make a plan, stay the course, and it will happen for you.

    Cheers!

  • Blogging Banks July 31, 2009, 9:04 am

    I would recommend that they buy a house, roll the credit card debt into the mortgage if they are approved for more than what the house costs, and then start paying off the house.. Why pay rent, when you could clearly afford a house?

  • Miya July 31, 2009, 2:45 pm

    This is an interesting recommendation that I would like to dig into more. According to our financial situation, I am not sure if we are qualified a mortgage or if we can affort it. I live in Metro Vancouver where the average of housing is around $450k. My family are . A townhouse would be ideal for the size of my family 4 adults and one infant which could easily cost $400K in my working area. We have 5% downpayment from RRSP. But our credit scores are bad (620-650), I don’t think the rate will be favorable (should be better than 19% credit card interest rate though.) Can I really consider that?

  • Four Pillars July 31, 2009, 5:58 pm

    Miya – I would strongly suggest not buying a house until you can get your finances and credit rating into good shape. Just don’t even think about it.

  • Subversive July 31, 2009, 6:10 pm

    Miya, it’s very unusual for a bank to reduce the limit on a LOC as you pay it down. The whole point of it is that the money is there and available to you whenever. However, if you’ve had late payment issues in the past, then maybe they would do that, I’m not sure. In any case, paying down the LOC leaves you an ’emergency fund’ while also reducing your monthly debt servicing. The thing you need to do is be very strict with your definition of ’emergency’ so that you don’t use it again (for example, the 52″ Plasma TV on half price at Best Buy is not an emergency:).

  • Frugal-Wannabe August 3, 2009, 1:46 pm

    Miya, I think the majority agrees that paying off the high interest credit card debt is #1 priority. Rolling the cc debt into a mortgage is also a good idea, espeically while mortgage rates are fairly low… apply for a pre-approved mortgage and see what the bank gives you…maybe go through a mortage broker who can find the right bank for your situation. Another altnernative is to find a lower rate credit card. I transfered my cc debt to a 3% mbna cc. I’m making large monthly payments (always pay at least double or triple the min amt due) and am focused on reducing that debt first.

    My question to the group is what if:

    a. have $25k in cc debt but under low interest payments
    b. cant contribute to rrsp bc employment pension plan takes up all rrsp room
    c. net take home pay $60-70k pa
    d. already have a low interest mortgage
    e. havent invested in a TSA or stocks yet (so no investments)
    f. dont have emergency fund yet

    how would you prioritze your finances?

  • Ms Save Money August 3, 2009, 1:55 pm

    Miya,

    Take it easy – one at a time first.

    Pay off debt –> increase credit score –> improve skills –> get better higher paying job –> save money —> buy a house

    Good luck!

  • cannon_fodder August 3, 2009, 2:27 pm

    Frugal-Wannabe,

    I would need to know if you have children, what the interest rates are on the CC debt and the mortgage (and whether the mortgage is fixed or variable and its term plus outstanding balance) plus your age (and spouse if any), # of years with BC employment pension and any anticipated milestones (having children, going back to school, retirement age, getting married, etc.)

    It is quite complicated to give the best answer. General answers can be provided when furnished with general information.

    Perhaps you may want to submit your details to FT as a ‘Case Study’.

  • financial planner August 19, 2009, 2:35 am

    As many people say, but not everyone, every situation is different. In many situations, most financial planners would advise to keep contributing to a retirement plan. In almost every situation, advisors would advise to keep contributing to an emergency fund. In this situation, it would appear that almost all your free income should go to paying down your debt because it is so large. Unfortunately, this is just a bad situation which will be harder to get out of than in to.

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