Spring cleaning time - Tidy finances could mean significant savings

Tidy finances could mean significant savings
When it comes to the harbingers of spring, the urge to house clean is on par with seeing your first robin or the first tulip straining for the sun. But as your thoughts turn towards tidying up winter's accumulated clutter in anticipation of more pleasant days ahead, why not consider cleaning up your household finances while you're in the same state of mind?

Debt is on the rise
A recent Ipsos-Reid survey indicated that since 1999, the level of Canadian household debt has increased by an average 18%, from roughly $57,000 to $67,000. Of equal concern is the statistic that almost half (47%) of Canadians between the ages of 25 and 64 have put off restructuring their debts in a manner that minimizes the amount of interest they pay. This could mean that even though many Canadians could benefit from the lowest interest rate environment in almost five decades, many of us are still paying unnecessarily high rates of interest on outstanding credit card balances and fixed-rate mortgages, which constitute the largest portion of average household debt.

A closer look at the survey supports this point of view that many of us may not be taking advantage of today's lower rates. Of the respondents, 75% indicated that they have come to accept debt as just a regular part of their day-today expenses even though 85% said they'd have more financial freedom if they had no debt at all.

Debt and inefficiency
In a similar vein, a study conducted two years ago by professors at Wilfrid Laurier University, uncovered some interesting details about how Canadians manage their finances. The study revealed that while Canadians had invested $161 billion in low-interest, non-registered deposits, they continued to carry $144 billion in high interest, credit card debt. The report also noted that Canadians typically utilize at least nine different banking products split between an average of two financial institutions. This suggests that many of us are spending a considerable amount of time and effort managing our day-to- day finances.

What this could mean to you?
What these studies reveal is that there is an opportunity for many Canadians to better manage their debt. By incorporating better borrowing strategies into our financial plans, it could help many of us organize our debt in a manner that helps us achieve our financial goals.

Here are a few spring cleaning tips you might consider that can help you clean up your finances:

1. Restructure:
Look for ways to shift your high-interest credit card debt to a lower-interest vehicle. The Laurier study concluded that the average Canadian was carrying a credit-card debt of approximately $2,000. Assuming a 19% interest rate, that could be costing you $30 or more per month. If that debt were transferred to a lower-interest vehicle like a home equity line of credit, your monthly interest cost would drop to approximately $7 – an annual savings of about $250.

2. Variable rate vs. fixed:
Most Canadians (about 60%) prefer the security of locking in their mortgage at a fixed rate. However, there is a high price to be paid for this comfort. Historically, five-year fixed rates have averaged between 1.35% and 1.50% higher than Prime. Today, for example, that added sense of security could be costing you 1.60% – or $1,600 a year for every $100,000 outstanding on your mortgage.

In today's low interest rate environment, variable rate mortgages are a real winner. You may even want to determine the cost of renegotiating your existing fixed-rate mortgage with the idea of moving to a lower interest rate alternative. In the long run, it could save you substantially in interest costs. Professor Milevsky of York University concluded in a 2001 study on interest rates, that over the past 50 years Canadians would have saved themselves an average of $22,200 for a $100,000 mortgage over a 15-year period, if they had chosen a variable-rate mortgage instead of locking in for a five-year term.

3. Prepayments:
Some prepayment options allow you to pay down up to 20% of your original borrowed amount annually, or increase your payments by 25% per year. But as effective as these prepayment options are in reducing your borrowing costs, it's estimated that over two-thirds of Canadian mortgage holders never contribute an extra penny towards their mortgage principal.

Why? First of all, it's not convenient. Secondly, when push comes to shove, there are always other things to spend your money on. And finally, people simply resist handing over the occasional "windfall" they've worked so hard to save. If this sounds familiar, consider looking into a mortgage vehicle like a flexible mortgage account. These accounts enable you to pay down your mortgage when you want, but take the money back out when you need.

4. Short-term savings:
If mortgage rates are at historical lows, so is the rate you're getting on short-term savings and GICs. If your "nest egg" contains these types of low interest-bearing securities, consider converting these savings into cash to pay down your mortgage or higher interest rate debts. In the end, you'll "save" more in interest than you'll likely ever "earn" on that money.

If you would prefer not to lose access to your savings, consider transferring all of your debt to a line of credit (preferably secured, to get the lowest rate). This will allow you to consolidate all your outstanding debt at a low variable interest rate, thereby allowing your short-term savings to work at lowering your interest costs.

5. Income:
Many of us are unaware that the type of bank account we open can be a powerful tool that can actually help reduce the costs of carrying outstanding debt. After all, the typical Canadian experience is to see our salaries deposited into our chequing account, where it earns virtually no interest, and then quickly evaporates as we cover our day-to-day living expenses. Anything left over at the end of the month either sits there or gets invested.

But when you think about it, we should treat the income we receive the same way we treat our short-term savings: deposit it against our debt to lower the principal while saving interest (in aftertax dollars) at the same time. Any bank account that allows you to automatically manage your finances this way will provide a real advantage when it comes to managing your debts.

6. Shop around:
There are a number of possible options to address each of these recommendations, from a secured line of credit to strictly variable rate mortgages to high interest chequing accounts. And, there's a good chance that many Canadians are utilizing one or more of these options already. After all, the average Canadian reports using nine different banking products at any given time.

Instead of splitting your banking needs across multiple accounts held with a number of financial institutions, there is another option available. It affords a simple, convenient and efficient means of accessing many of the above suggestions in a single account. To learn more, visit www.manulifeone.com or speak with your financial advisor about Manulife One.

Whatever you do, while you're tidying up the house for a new season, give some thought to tidying up your day-to-day finances as well. One small step could lead to significant savings — and help you become debt-free years sooner!