Financial Know-How

Only about a quarter of the adult population of North America has a will. The biggest misconception about wills is that it is drafted by lawyers for rich people with a lot of assets. This may be true to some extent but it should not hold you back from taking the time to write your own will, sign it, and keep it in a safe place just in case something happens to you. This is especially true if you have children.


The purpose of having a will is that your final wishes are made clear. The existence of a will makes it legally binding that your final wishes are carried out according to how you would like. Not only will your assets go to those you choose but your children will be raised by those you feel is best suited to take on that responsibility. Without a will the courts will apply a formula they have already set which may go completely against your true wishes.


Here is an example. Say a man just remarried, has no children, and he brought in all the assets to the marriage. During their honeymoon, him and his second wife both die from a plane crash. He is survived by his siblings parents, and his ex-wife. And she has a brother. If the man has no will (dies intestate), then where does all his assets go? Not to his parents, siblings, nor even his ex-wife. According to succession law, all his assets will transfer to this wife at the moment they both died and therefore both their assets will transfer to her next of kin, her brother. This is most likely not what he wants but this is how the law works given he does not have a will. His family could try to fight for it in court but this would make an extremely tragic event even more difficult on both families. Now imagine if the case involves a child and the courts assign guardianship to someone that is not your choice.


The reason I encourage people to take the time to write a will is because it is much simpler than you think and doesn't require a lawyer or any money to make. Just take out a pen and piece of paper and state what you want to happen in the event that you die.


Important things to include in a will are:

• The beneficiaries: State which people you want to inherit your assets and how you want those assets divided.

• The Executor: State who you want to be in charge of carrying out your last wishes.

• Guardians: State who you want to be the legal guardian of your children in the event of your death. You can also state a second choice if for some reason your first choice cannot take on that responsibility.

• And anything thing else that you think is important to you. How you want to be buried (or cremated) or whether you want your organs donated, etc.

After writing the will, sign and date it in front of two other people (witnesses) and have them sign (preferably with their address and occupation printed below) to confirm that they witnessed your signature. The witnesses should not be a spouse, beneficiary, or executor of the will. They do not need to know the contents of the will, only the fact that you signed the will yourself. You now have a fully legal will. Even if you do not have it witnessed, the will would still be legal if it could be proven in court that you signed it yourself.


It's that simple. Do not be fooled by the term "legal will". All wills are valid even if it is not drafted by a lawyer. Having one legally drafted is not completely necessary unless your situation is complex and you want to hire a professional to ensure everything is covered in your specific situation. In most cases, a simple one drafted by yourself is sufficient as long as it clearly states what you want. So if you believe that you only need a will if you have lots of money and have to pay for a lawyer, then I hope this tip will convince you to make a simple and free will for yourself. Even if it might not cover every important detail like one written by a lawyer, it will still include the most important wishes you have.


So why not take the time and hand write a will stating what you want and update it every five years or as often as you wish. Put it away where you put your important documents just in case something unexpected happens to you. Do it not only for your own benefit but for the benefit of those you leave behind. It's much better than not having one at all.

Since capacity (your ability to make the monthly payments) is usually the biggest determinant in most credit applications, I will focus on this factor in today's post. Specifically, I'm going to show you how you can take the two debt ratios that banks use to gauge capacity, TDS and GDS, and figure out what's the most you will likely qualify for based on your current income and expenses.

As a quick reminder from my previous post "The 5 Cs of Credit" that TDS looks at your overall monthly obligations and GDS looks only at your housing obligations as a percentage of your total gross income (before taxes). Banks want to see these ratios under 40% and 32% respectively. Since you know these two maximum percentages, you can calculate roughly how much you can qualify for.

The easiest way to explain this is to use a simple example. Say you want to buy a car. You have an income of $40000, pay $800 rent, and have a $3000 balance on your credit card (therefore minimum payment is 3% or $90 on credit card). But before going out to look for a car (or a house for that matter), you want to know approximately how much you can qualify for. Here is an easy and effective way to determine that yourself.

From the example, if maximum allowed TDS is 40% of income, then 40% of $40k is $16k or $1333 per month. That means the banks want to see your total overall monthly obligations to be no more than $1333. Since $800 plus $90 is being used to pay for rent and credit card, then the bank will let you borrow up to an amount where the monthly payments is (1333-890=) $443/month. To find out how big that loan is, use a loan calculator that allows you to invert the calculation. BMO has a good one.

So if the bank is currently offering a 4 year loan at 10% interest, then given a payment of $443, you will qualify for a $17,466.67 loan maximum. A 5 year loan with the same rate qualifies you for up to $20,849.96.

A quick check of the GDS shows that 800 / (40000/12months) = 24% so you're below the 32% guideline.


For a mortgage application the calculation for housing costs gets a little more complicated because you have to add in other costs of maintaining the home in addition to the monthly mortgage payment. In a mortgage application, total monthly housing costs  = monthly [mtg pymt + property tax + heating + fire insurance] + 6 months condo fees if applicable. If you don't know these other figures then ask around to estimate it. If you found a home already then the MLS listing and realtor can give you those figures for that particular home. Just minus those totals from the 40% of your income to get the mortgage payment amount and use an invertable mortgage calculator (I'm in the process of finding one for you) to figure out the mortgageable amount or use a normal mortgage calculator and do trial and error to find the mortgageable amount.
 
The calculation above is generally used by all adjudicators in every type of credit application. From credit cards and overdraft protection to loans and lines of credit. Each bank may have different lending policies but they all follow the same 32/40 lending guideline.

One thing I want to remind you of is that capacity is only one of the 5 Cs of Credit that determines how much and whether your credit application gets approved. But it is generally the most important factor in most applications, especially for larger amounts like a mortgage or car loan. Also, some financial institutions may calculate your TDS based on your credit limits and not your minimum monthly payments.

There are three certainties in life. Death, taxes, and bank fees. Luckily having a line of credit can help reduce the last one.

Initially, banks started off not charging their customers for having deposit accounts because they can use the deposits as capital for investment. Somehow things took a wrong turn for the customers and now everyone must pay a fee in order to access their own money while bank profits soar. These fees range anywhere from $4 to $25 a month and that does not even include extra fees like over activity, cheques, and overdraft protection.

Bank fees are a huge and dependable cash cow for the banks and they would probably kill me for putting this out there but I will anyways. I am going to explain the benefits of using your line of credit as your main chequing account. And the benefits are huge.

First, there are no monthly fees on your a line credit. Because it is a credit account, banks want to encourage their customers to have and use them so there are no monthly fees to have this account. Not paying for monthly fees on a chequing account can help you save anywhere from $50 to a couple of hundred dollars a year. It adds up.

Another way banks encourage you to use your line of credit is by offering cheques free of charge. Ordering cheques on a chequing account could cost anywhere from $8 to $40. With a line of credit you get them free and unlimited.

Thirdly, lines of credit allow pre-authorized debits and credits just like chequing accounts. That means you can give a void cheque to an employer for direct deposits and to creditors and billing companies to directly debit from your LOC just like you would with your regular chequing account. Other than having a positive balance, I don't believe there is anything a chequing account could do that you can't do with a line of credit.

The final (and for myself the most important) advantage is that you can have unlimited transactions free of charge on your line of credit. This is especially useful since most banks allow you to attach your line of credit account to your debit card just like a chequing account. This means you can use your line of credit any place that accepts debit cards. No cash but you want to buy that $1 bag of chips? No problem. Finish that bag in 2 minutes and want to buy another? No problem. Pay all your bills online for free. No extra costs and also not be bounded by the number of transactions.

Now I am not trying to encouraging people to use or apply for a line of credit so they can go into debt. I'm just trying to help those that are already in debt to take advantage of an opportunity that will help them save money. This is what this site is about. Making that switch to use it as your main chequing account will save you more money than you realize in the long term.

No monthly fees, unlimited transactions, AND cheques all for free. You can't find a better deal than that. Now if only we could figure out something like this for the cellular carriers.


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Update: It has been brought to my attention that I did not state that there are no deposit holds on a line of credit like there is on some chequing accounts.

This is true. This is another advantage which I forgot to mention. If you max out on your line of credit and deposit a cheque, there are no holds so you can have access to the newly deposited amount immediately. This may not be true for some chequing accounts which could hold your deposit for up to a week. The reason for this is because the bank has already granted you a credit facility (with your loc) but none was granted for your chequing account. They are separate. Yet another good reason to use the line of credit as the main chequing account.

Most people believe that if you always make your payments on time then you will have good credit. This is not true. The only thing that making your monthly payments on time does is ensure that your credit rating does not drop. Your credit is actually determined by more important factors. These factors are what I call long-run factors.


Think of it like this. All things being the same, if you never ever miss a monthly payment, your credit score will reach to a certain level and stay there. That level is called the long-run level or potential level. (I use the term level, rating, and score interchangeably here.) The biggest determining factors of your long-run level is the amount of open debt you have and the length of time you've had them.


Otherwise known as revolving debt, open debt are things like credit cards, lines of credits, and department store cards. They allow you a lot more flexibility than closed debt, such as loans and mortgages. How much you owe on these debts will be the biggest factor in setting your long-run or potential credit score.


What credit agencies look at is how much you owe as a percentage of the total open credit limit. Say you have two credit cards, one has a $2000 limit and another has an $8000 limit. You have a total open limit of $10000. If you own $1000 on each, you owe 20% of your total limit.


To understand and manage your long-run or potential level, think of the 30-80 rule of open credit. If you owe anywhere between 1 and 30%, your potential level will increase to its highest level dependent on how long you have had these two credit cards. The longer the period the higher your long-term level should be.


Now if you owe anywhere between 30-80% and you always make your payments on time, you should not see a change in your potential or long-run level. If you increase the amount you owe to anywhere between 80 and 100% of your total limit, your credit score will go down to a lower potential level even if you always make your payments on time.


That being said, you should also try to make your monthly payments so as to not hurt your credit in the short-run. Being late on any payment for more than 1 month will decrease your score in the short-term. Only by not being late again for a long enough period of time will your credit score eventually start going back up to the potential level (which I have explained is determined largely by the percentage you owe on your total credit limit and the length of time you've had these credits).


It's important to note that financial institutions will only report late payments to the credit agencies if you're over 30 days late. That means it's okay to be late on your loan or mortgage payments as long as it's not over 30 days late. Being over 30 days late will decrease your score even though there is no change in your potential level (given no change in the percentage bracket of open credit you owe).


So those are the two biggest things that affect your credit rating, which luckily you have control over. The lesson here is to never be over 30 days late on any payments so that it doesn't negatively affect your credit score in the short-run, owe less than 30% of your total open credit to raise it to its highest potential, and never close your oldest credit facilities. And try not to owe more than 80% if you can. That means the next time that lady at the mall offers you a credit or department store card, you'll be doing yourself a favor by getting the card even if you don't plan to use it as it will only increase your total open credit limit and lower the percentage that you owe.


Now of course there are many other factors. As I've mentioned, the longer you've had the credit card, loan, etc, the higher your potential credit score. In the short-run though, there are other factors you should keep in mind. One is that the more times someone (the bank, etc.) checks your credit history within the last 12 months, the lower your credit score. This is because it is a sign to credit agencies that there's a problem. Most people don't need multiple checks on their credit score in a short span of time unless there's a problem. Each time anyone checks your credit, your credit score decreases, at least in the short-run. So don't let anyone check your credit unless it's absolutely necessary.


Another sign of instability is the amount of times you've changed jobs or change address. The more that happens and the agencies are aware of this, the more downward pressure there is on your score. But luckily this is a short-term effect and the score can be re-raised eventually to its potential level.


Depending on how long one has had the credit accounts, if you have a spotless credit history but your open credit utilization is over 80%, you will have a potential score of about 650.


So now you know. Always paying your bills on time gives you a spotless credit history but it does not mean you have the highest credit score possible.


Well I hope you understand what I've explained. Use it to your advantage and make sure everyone around you, your family, friends, and coworkers, are fully aware of the mechanics behind what determines their credit scores. This is how it works in Canada and the US and this is likely how it works in every other country.