Tuesday, March 8, 2011

Money Management Part Three - Understanding the Terms of Your Credit

"Wow... that was fast!"  Jill was reading through their credit reports that had just arrived in the mail that morning. "This is a little scary, you know... look how much information they have on us!   But it all looks right to me.  What do you think?"  She handed the papers over to Jack.

"Looks good to me... I wonder what you would do if there was a mistake on it, though?"

"Let's ask Richard - he seems to have a handle on all of this stuff."  Jill went to the phone, and returned a few minutes later.  "Turn to the back page - there's a form there that you fill out and send in to challenge mistakes or update incorrect information.  He says it's usually pretty straightforward."

"Good to know!  So when are we getting together next?"

"He suggested Saturday morning - you have the weekend off, don't you?   The forecast looks wet and cool, so he suggested we meet up at the indoor playground, let the kids blow off some steam while we have a chat.  Apparently they have some free passes.  How do they find out about all these things?"  Jill shook her head.  "I need to take some tips from Jane, I think!"

Saturday dawned gray and rainy, so they all met up at the playground, checked the kids in to the play area and headed to the tables to enjoy a coffee and have a chat.   "How did you do at collecting your paperwork?"  Richard asked.

"Great!  It was easier than we thought to get everything together, and the credit reports came in just a couple of weeks.  Everything on them looks fine.  Some of the loan papers are a little scary, though."  Jill grimaced.  "Especially the interest rates - ugh.  And what on earth is a balloon?"

"Let's have a look."  Richard spread out the papers across their table and started reading.  "Well, the good news is, you're actually not abnormal.  Your debts are pretty much the average for Canadian families these days."

"Really??"  Jack looked surprised.



"I know.   So... you've got a line of credit... the limit is $9,000 on that one.  What's your balance?"

"That one... that's pretty much maxed out.  We might have a couple hundred available on it, but we tend to use it pretty frequently.  There's always a little more month left at the end of the money, you know?"  Jack shrugged.

"Don't I know it.  I sure remember that feeling.   Next up, credit cards... $2,400 on the Visa and $3,000 on the Mastercard, limits are $3,000 and $4,000.  So you're not maxed out on these - good work!"  Richard smiled.  "Right there you're ahead of a lot of people."

"That was thanks to a tax refund this spring - we split it between the cards and paid $2,000 on each of them.  It sure was a nice feeling to see the balances drop so much."  Jill looked down.  "The balance has come up again a bit since then, though."

"It happens.  But you'll get there!  Don't get hung up on the past, Jill - it only gets better from here," Jane encouraged her friend.

"Student loan.  Wow, you're still paying on that?"  Richard looked dismayed.  "How long have you been out of school?"

Jack felt a little defensive, but explained.  "We went through a rough time financially a few years back, and that seemed like the best place to help the budget.  I called up and changed the payment schedule to interest-only payments for what... two years, I think?  I'm making regular payments again now, although they're smaller than they originally were.  I'm making slow progress, but there's just no room in the budget to raise the payments right now."

"Gotcha.  Well, at least that's one with a lower interest rate, and the student loan people can be pretty good to work with.  Now, what's this other one for $3,000?  24%?!?  Ouch."

"That's for our new appliances when we moved in.  They offered a package deal - fridge, stove, dishwasher, washer and dryer, and no payments or interest for 18 months.  That time is just about up, though, so the payments are due to start in a couple of months.  We have made a few payments on it, and put part of last year's tax refund toward it as well."  Jill explained.  "There's some extended warranty coverage in there as well, I think."

"Oh, definitely.  These places always require their own 'total coverage' policies as part of the purchase."  Richard suddenly looked annoyed.  "I wish they were a little better at explaining the terms of their loans, though.  Pop quiz for you - when does your interest start to accumulate?"

"After the eighteen months is up, I would imagine... right?"  Jack guessed.

"Well, sure.  Sort of.  Except... all of that interest you haven't been paying these 18 months?  Well, that will all be added to the account one day after those 18 months are up.  It's only interest-free if you actually pay it off before the eighteen months is up.  When you buy things in this way, the interest actually begins accumulating from the moment you buy. It's then canceled if you pay the principal within the terms of the contract. But if you are even one day late, you owe the interest on the unpaid balance for the entire period."

Jill felt ill.  "Are you serious?"

"Very serious.  We need to see what we can do about this one as soon as possible.  When does it come due?   November 30, okay.  Well, we're just coming up on the beginning of August... we'll be able to do something."  Richard nodded thoughtfully.  "We need to get to work, though.   What else do we have to work on here?  Your car - this should be pretty simple.  Oh."

"What?"  Jack asked, concerned by the grim look on Richard's face.

"You have a balloon loan - were you aware of that?"

"A what?"

"A balloon loan.  Check out this line here, 'Final Payment' - it's almost $3,000."

"What??" Jill hadn't really looked at this one - it was the loan paperwork for Jack's car.  "What is that about?"

"Well, a balloon loan sort of works out like a lease.  You make payments through the loan period, and then at the end, there is a payout amount.  You have three choices at that point - give the car back, pay the amount in full, or negotiate new financing with the lender to write you a new loan for that amount.   But your best option is to have the loan paid off before then, avoiding the whole issue.  Some people do that by selling the car after a few years - those people like balloon loans because the payments are lower and they're not planning to keep the vehicle long-term anyway.  But for most people this is a bad kind of loan agreement to take on, because 4-5 years down the road when your loan is up and you have to make this big payment, your financial situation won't have improved much over where it was when you first signed the loan... so you end up in another high-interest loan for another year."  Richard shook his head again.  "I hate these.  And I'll bet you didn't even realize this was part of the agreement, did you?"

Jack shook his head and shrugged.  "Maybe... but I don't think so.  When I bought it, we needed a car.  And this was one with a manageable payment and the options we needed... I guess I let the salesman gloss over the details of the financing."

By now Jack and Jill were both looking a little beaten, facing a financial picture loaded with consumer debt and some uninformed decisions that had led to a real mess.

"Hey - don't get down on yourselves.  We've all been there.  The important thing is, your eyes are open now.  You're facing the reality of the situation and getting ready to do something about it."  Richard leaned back in his chair and watched the kids playing.  "If you need motivation, you've got a couple of really good ones right over there."  He leaned forward again.  "Ready to move forward?"

"Definitely."  Jack nodded and put his arm around Jill.  "What do we do next?"

"All right.  Next up, we work out your budget.  You've tracked your spending and you know where the money has been going - now it's time for you to start telling your money where to go."

Previous Posts in this Series:

Money Management Part One - Track Your Spending
Money Management Part Two - Getting the Big Picture

Additional Reading:

Financial Consumer Agency of Canada - Understanding Your Credit Report and Credit Score (pdf)
Financial Consumer Agency of Canada - The Cost of Payday Loans (pdf)
CBC Marketplace: No Money Down
American Chronicle: Balloon Loans for Car Purchase?

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