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Negotiating the best rates on loans and lines of credit

Car keys and approved loan application

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The following excerpt is from Chapter 9 and 10 of Vesna Milevska's book Financial Hacks.

Chapter 9: Loans

Getting a loan from a bank may be a good alternative when you need to borrow money for the short term (5-10 years) with a fixed interest rate and fixed monthly payments. Loans are typically for five years and interest rates vary. The most popular loans are debt consolidation loans, student loans, car loans, RRSP loans, and business loans.

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If you find you cannot afford your monthly payments on your credit cards and are only able to make the minimum payments, consolidate your debt. This will allow you to get a lower interest rate and allow you to pay off the debt in about five years.

Do not forget to negotiate your loan rate! If you ask for a 0.5% lower rate, you just may get it.

Note that when you consolidate debts, there is a high probability that you will need to close some of your credit cards.

RRSP loans are very popular during the winter RRSP season. They are usually set up with lower interest rate than regular loans. At present, the rates are about 5%. With the money you borrow, you will make a contribution towards your retirement savings. A few months later, you will receive a tax refund (remember, the amount of the contribution is not taxed in the year in which the income was earned). You can use the refund to pay off the interest and part of the capital that you borrowed. Your contribution will stay in the RRSP, working for you tax-free, until such time as you withdraw the money. The loan itself can be repaid from your monthly income.

RRSP loans typically have to be repaid within one year. They are usually not restricted in terms of being paid off earlier than the original term with no penalties. Ask the bank!

An alternative when you get your tax refund is to pay off any outstanding balances on your credit cards. That way you will have switched your debt from a high interest vehicle (the credit card at 20%) to a lower interest one (the RRSP loan at 5%).

Auto loans are generally more expensive with the banks (7% to 9% at present) than with the car dealerships. First, ask your dealership about the interest rate and term (amortization period). Then, compare what your bank can offer.

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Business loans are another type of loan and you can use this credit if you have a small business. They are cheaper (8% to 11% at present) than credit cards (remember that 20%), but not personal loans (as low as 3% to 5% if you have a good credit rating) and the interest you are paying is tax deductible. Interest on personal loans is not tax deductible unless the borrowed money is used to make an investment on which you expect to make profits, such as buying stocks or mutual funds.

Borrowing money to invest (except RRSP loans) is very common with investors. All the interest paid on the loan is tax deductible. If you can borrow money from a bank to make investments, you can access markets at any time, even if you do not have cash of your own available. Of course, this is a big problem if the stock market never makes money for you. If you do borrow for investment purposes, you should have monthly payments you are comfortable with and make sure you declare the interest on your tax return.

A very interesting and popular type of borrowing for large investments is a loan against the equity in your house. I will talk in the detail about this in chapter ten (Line of Credit).

Tips on Loans

Always ask if you can make a lump sum payment on your loan without penalties. Apply every bit of extra money towards the loan principle. You will pay your loan faster and you can start saving for big financial goals.

Loan applications are approved based on your annual income qualification and credit rating.

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Negotiate the interest rate you have to pay. Be reasonable in your demands and prepared to go to a different bank if you can't get the rate you want. No bank will lend you money at less than the prime rate. 17 Many will try to charge you prime plus 2%. You may be able to settle on prime or prime plus 0.5%.

Experiences with Loans

I have a friend who had $45,000 worth of debt on different credit cards. She was making minimum payments every month, which was half of her monthly paycheque. It became unbearable for her and she was considering bankruptcy. After we reviewed her statements I convinced her to consolidate her debt with a five-year loan.

Her monthly payments on the loan were cut in half. The best part was that the bank that provided the loan closed all but one of her credit cards and it had the lowest interest rate. She paid her loan off earlier than expected and she started depositing the same loan payments she was used to into a savings account. Seeing her savings grow every month encouraged her to save even more and in two years she had enough money for a down payment on her first home. Her credit rating improved dramatically. It is never too late to turn your life around!

17 The prime rate is the rate each bank charges its best customers. It is usually about 2% above the rate the Bank of Canada sets weekly for short-term lending of money to the banks.

Chapter 10: Line of credit

A line of credit can be a source of short-term cash. Banks usually provide them to people who have good credit ratings, not just high annual incomes. A higher credit score will generally allow you get a higher approved limit on a line of credit. Generally, lines of credit have a maximum of $50,000.

The interest rate for a line of credit is based on banks' prime rates plus a certain percentage. Again, a better credit score means you will get a better interest rate. Lines of credit often have interest rates similar to those for personal loans (about 3% to 5% just now).

Minimum monthly payments are 3% of the balance plus interest (if you have any balance). They do not have any annual fees if you do not use them. So, any time you need cash, you can draw on your line of credit without going through specific negotiations with the bank. However, you need to be sure you make those minimum payments and periodically put in more to your account to get the balance back toward zero.

You can find a line of credit useful for anything you need on a short-term basis. I recommend this should not include shopping for your toys. My recommendation is to have this as emergency cash if you do not have any savings. Another use is if you have not paid off the full balance on your credit card, use the line of credit because it has a lower interest rate. Use your line of credit wisely. It is not your chequing account or your shopping credit card. Interest is charged immediately when you withdraw any money. Unlike a credit card, there is no short grace period during which interest is not charged.

Depending on your credit rating, a bank may provide you with an unsecured line of credit, where you do not have to put up any assets on which the bank could draw if you miss payments, or it could offer a secured line of credit. That is, they would only lend you money if they were holding some asset of yours. That asset would normally be something financial, such as a GIC, stocks, bonds, or mutual fund shares. You may want to have a secured line of credit anyway, as you may then get a lower interest rate.

Tips on Lines of Credit

Lines of credits are frequently offered by different banks and have different interest rates. Always choose the one with the lowest rate. The biggest trap for people who are not disciplined is taking lines of credit with several financial institutions and using them for big item shopping (for example, TVs, cars or long vacations). In no time, you can end up with $20,000 to $30,000 worth of debt. Again, please consider them as emergency cash for the short term and have a plan for how you will pay off the balance.

If you are thinking of using your line of credit for the down payment on a mortgage-do not. Borrowing money against your line of credit for a down payment will work against your ratios for qualifying for a mortgage. Most lenders do not like borrowed down payments and you will need to confirm your down payment is not from borrowed funds. Effectively, you have to show your savings/investment accounts.

Experiences with Lines of Credit

Having a line of credit may be quite important early in adult life. That is a time when you are acquiring all sorts of things, but often you won't have all the cash you need to do so. We used our line of credit a lot when we were young, especially when we were renovating a house. As we got older, we found we didn't need to use our line of credit much. Eventually, we were informed by the bank that we would have to pay a fee to maintain our line of credit. At that point, we closed the account.

Excerpt of Financial Hacks is courtesy of Vesna Milevska, copyright registration No. 1083320, registered January 7, 2011

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