Home' Trinidad and Tobago Guardian : July 26th 2015 Contents JULY 26 • 2015 www.guardian.co.tt SUNDAY BUSINESS GUARDIAN
FINANCIAL ROAD MAP | SBG7
aymond Jones, 43, and
his wife Marcia, 39, live
in a three-bedroom
duplex with their two
children: Sahara and
Ethan. At the back of the
property they built a
room annex for Ray s mum, who passed away
a few years ago. The space is now being rented
out for $4,500.
Mum s medical bills forced them to get into
some debt and since then their level of bor-
rowings have increased as they alternate refi-
nances between two bank loans to clear credit
card debt currently maxed out at $35,000 (25.5
These loans are both at 13.5 per cent APR
and have balances (and payments) of $23,000
($950) and $34,000 ($1,400) respectively.
Marcia also has a car loan of $2,300 with five
years to run; APR 12.5 per cent.
The last tenant they had was evicted after
doing much damage and the Joneses were
forced to refurnish using hire purchase at $875
per month; the interest is a whopping 36 per
cent APR and they have 32 months to pay off.
After paying all of these debts, including a
mortgage of $5,500, Ray and Marcia hardly
have any money left over and depend on the
rent and their credit card to buffer monthly
expenses, which averages about $6,000.
The cash-strapped Joneses currently have
a debt service ratio (DSR) of 70 per cent but
there is hope on the horizon as their mortgage
officer offered to consolidate their debts at 5.5
per cent per annum with payments of $6,700,
and a maturity date when Marcia turns 65.
The consolidation will bring down their DSR
to 40 per cent.
Whilst this seems as the best and only
option, the Joneses have a few concerns:
1. If Marcia clears off her car loan now she
will lose the free full comprehensive insurance
coverage that came with the car deal. She has
one more year of the benefit left at a value
2. Marcia s philosophy is that short-term
loans are better because she can repay them
quickly and save on interest. She is slightly
opposed to combining all of their debts and
stretching them out to age 65 incurring sig-
nificantly more cost.
3. The couple is also not thrilled by the idea
of tying up the equity in their property with
all that debt.
Nick's Assessment & Advice
In the Joneses case it is clear that they are
refinancing their bank loans to temporarily
clear off part or all of their credit card debt.
With a monthly average living expense of
$6,000 and a rent of $4,500, the shortfall of
$1,500 would accumulate on the credit card
until the end of the year when they approach
their bank for funds.
It is doubtful that this refinancing strategy
would continue indefinitely in light of their
current DSR. What the Joneses would have
realised was a lengthening in their pay back
periods in order to keep installments affordable.
The proverbial "buck" will eventually stop
and the Joneses may be forced to make some
adjustment to their finances and to their phi-
Free insurance & cost of
First and foremost, the Joneses should bear
in mind that there is "no free lunch" and
someone must pay the free insurance premium;
that someone is the borrower. This cost would
not be itemised in their loan disclosure state-
ment because it is actually built into the interest
of the loan.
After Marcia s final policy renewal goes
through she will subsequently have to pay
premiums directly out of her pocket.
We were not told what was the balance on
her car loan but, based on the variables given,
we estimated that it might be around $102,232.
Table 1 shows how much interest she would
pay over the next 12 months using an APR of
12.5 per cent and a monthly payment of $2,300.
If she shifted this debt to the consolidation
loan at 5.5 per cent she would reduce her inter-
est rate by seven per cent, which is more than
half. If she paid the same $2,300 towards the
new 5.5 per cent loan she would retain enough
wealth to cover most if not the entire $5,300,
which represents the insurance premium.
Of course the new loan would not have a
monthly payment of $2,300 for the car debt
but instead part of the new installment of
$6,700 that relates to the car would be about
$617 per month (5.5 per cent, 26 years,
$102,232). $617 over 26 years would be
$192,380, which means that the interest cost
in the long run would be $90,148 ($192,380
So Marcia is right in saying that she would
pay significantly more interest if she switched
to the long-term debt instead of continuing
the $2,300 for the next 60 months; even at
the higher 12.5 per cent ($2,300 x 60 months
= $138,000 - $102,232 = $35,768 in interest).
This principle would apply to each of the indi-
vidual debts brought into the consolidation
This discussion sounds all too confusing
So what is the point to all of this?
Is it that we are suggesting Marcia take the
consolidation loan and pay extra money to
make up the $2,300 that she was putting out
just save on interest and justify leaving the
$5,300 car insurance premium behind? Not
at all. This would defeat the whole purpose
of a consolidation which was to reduce their
monthly payments and free up precious cash
Persistent debt, cash flow or
This is the dilemma faced by many indi-
viduals who are considering bringing all debts
under a single payment at a lower interest
rate, spread out over a longer time frame.
There is always a cost. The question is which
is the lesser of both evils: improved cash flows
or interest cost? And would they actually be
saving on interest if they left everything as
is?The very fact that the Joneses have a debt
service ratio of 70 per cent means that they
will have a persistent (long-term) "short-term
debt problem". If they do not try to improve
their monthly disposable income, they would
be perpetually borrowing at the highest possible
rates to hold fast to their philosophy that
short-term is better.
Further, as they become more strapped for
cash and re-approach the refinancing table
every year the interest rates would probably
increase to compensate the lender for the
If the Joneses accept the mortgage officer s
offer to pay $6,700 per month, they would
see a $5,069 ($11,769 - $6,700) improvement
in their cash flow. This is not far from their
monthly living expenses of $6,000, which
they now buffer with the rent and credit card.
Instead, they would be in a position to save
every month, build a liquid cash reserve and
after that focus their energies and finances to
make lump sum payments towards the new
Equity & net worth
The Joneses also have a concern about tying
up their property s equity. Even though the
new loan puts an official charge against the
value of their home, their net worth has
remained the same.
In fact, the equity has helped them to
improve their financial position, which will
redound to an expansion of this very equity
and, by extension, their net worth.
F C C
How debt consolidation
can work for you
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