When used correctly, debt can be an effective financial planning tool to help reduce taxes and beat the banks.
On this podcast, we tackle some of the burning questions business owners have on how to structure their debt effectively.
How should I manage debt when COVID-19 subsides?
We don’t know when this is going to end, so our advice is not to wait and make the most of Government benefits available to you right now. These programs are designed to make sure we as business owners survive this challenging period. Take advantage of these loans now instead of taking on high-interest debts later.
It’s very unusual for an interest-free loan to be so accessible, particularly when 25% is eligible to be forgiven, such as the Government’s Canada Emergency Business Account. The impact of this pandemic will not be a forever problem, so having extra cash available to get us through is incredibly valuable.
We always encourage business owners to have a Line of Credit. If you set it up at a time when you don’t need it, it’s always there when you do need it.
Money is cheap right now; rates are the lowest we have seen for a long time. And despite what people tell us, debt is not always bad. If you can get a higher rate of return by injecting money into your business than you’re paying on a loan, take advantage of it.
What happens when we make minimum payments or interest-only payments? How do we get out of debt?
If you’re taking on high-interest rate debt such as credit cards and not even covering the interest, your debt is only going to grow. Try to consolidate your debts together in a low interest loan like a Line of Credit.
If things are getting out of control, review the Government benefits to see if you can take advantage of programs such as the Canada Emergency Commercial Rent Assistance. If you can negotiate rent with your landlord, it will free up monthly cash flow to keep afloat until things stabilize.
What happens to my debt if I die?
When the executor settles your estate; they’ll do an inventory of all your assets and all your debts. For the estate to settle and to pass on money to your beneficiaries, all debts need to be paid. If there are debts outstanding assets will be liquidated to pay for any existing debt.
If there are more debts than assets, this will not be passed on, as long as the debts have not been co-signed. If the debt is joint or co-signed, then the co-signer will take responsibility for that debt once you have passed.
Usually, banks will do their due diligence and won’t let you take on debt unless there are assets to back it up.
How do we decide whether to pay down existing debt, such as a mortgage or student loan, or use that money to invest in the market?
If it’s a high-interest rate debt like a credit card, then try to get rid of it. But in a lot of cases paying down debt, is not necessarily the immediate best option.
If you can use the money to invest in your business or take advantage of the current market you could come out on top. It comes down to your long-term goals and what life you want to live. Once you’ve aligned your goals with your cash flow, you are better placed to make these decisions.
A lot depends on your personality and ability to be able to handle risk; you must be comfortable with fluctuations along the way. In the short term you may lose money, but if you allocate it properly over a five-to-seven-year period, you should see growth. This doesn’t mean you have to invest for seven years; if the market grows you can take your money, you just need to be comfortable with a long-term timeframe.
If you do decide to borrow money to invest, make sure you can service the debt even if your investments go down. The market has proven us wrong many times in the last few months, we thought it couldn’t go lower, and it did. We thought it couldn’t recover fast, and it did. We don’t know where the market is going to go. Always take a long-term approach when borrowing to invest.
Real estate also is a leveraged investment strategy. Just because you don’t see the statements every month, you’re taking on debt to buy the property and banking on the value going up. You can’t push a button to get out of real estate, so it’s a significantly different relationship and comfort rate, but you’re still taking on risk.
If I want to invest in real estate should I take money out of my corporation for a bigger down payment or take on more debt so I can leave money in my corporation?
If you can and with interest rates being as low as they are, it makes the most sense to take on the debt personally if you are able to do so.
If you take a down payment from your corporation, you’re writing a cheque to CRA that you’re never going to get back. If you need $500,000 from your corporation to make a down payment, you must withdraw almost double to cover the tax.
Look at the big picture when it comes to tax and not just the lower rate.
Should I take a fixed or variable rate mortgage?
Work out the total cost of all payments over the term of your mortgage.
Most mortgage brokers recommend a variable rate. Typically, when you take out a variable rate mortgage it is posted much lower than a fixed rate. To make the fixed rate the more cost-effective choice over a five-year period, the Bank of Canada would need to increase prime 9 times or more by their usual increase of 0.25%.
People fear that variable-rate mortgages could see interests go up more than this, to 15% and above, but it’s an almost impossible scenario in a five-year timeframe.
What a lot of people don’t know is over 60% of mortgages get are broken before the five year term, and the penalties for withdrawing from a fixed-rate mortgage are about nine times higher than that of a variable mortgage.
Should I get a Line of Credit secured against my home?
We always recommend using a Line of credit to consolidate your debts at a lower interest rate.
The benefit of a Line of Credit is you have the option to only pay interest on the money you use. It’s also more flexible, so you can decide how much you pay down rather than being locked into fixed payments with a traditional mortgage. A hybrid is always the best option.
Access to money is important right now and a much better option than having to refinance, break your mortgage or take money out of your corporation. Take advantage of your equity.
If you’d like to talk through any of these strategies further book a call, we’d be happy to discuss.