Debt & Finance - Money Management

By taking a pro-active approach to managing your monthly income and expenses you will find yourself in a position to be better prepared to handle financial turmoil (i.e. the risk of falling behind on your monthly financial obligations such as your mortgage, rent and/or utility bills) and potentially avoid the risk of accumulating debt.

If you fall behind on your monthly financial obligations and begin to accumulate debts, itis likely that your creditor(s), or a debt collection agency appointed by your creditor(s) will contact you in order to negotiate a payment plan. The purpose of the payment of plan is to afford you the opportunity to facilitate the repayment of your outstanding debts while continuing to afford you the ability to continue to obtain the benefit of additional services from your creditor in the future.

In the event your financial circumstances result in you accumulating debt, the adoption of a regimented approach to managing your personal finances will help enable you to effectively manage and comply with any agreed payment plans and avoid incurring any unnecessary expenses or penalties due to non-payment (i.e. late fees, compound interest, bank foreclosure, eviction, etc.).

However, if you fall behind on an agreed repayment plan with a creditor it is likely that your credit will commence legal proceedings to force repayment of the amount owed to them and discontinue providing services in the future until the debt is repaid in full. Furthermore, if you fall behind on a repayment plan with a creditor and your debt is referred to a debt collection agency, under the Debt Collection Act 2018 the debt collection agency has the legal authority to impose debt collection fees and administrative fees.

As part of taking a pro-active approach to the management of your personal finances it is essential that you accurately account for: (i) your monthly expenses; and (ii) any periodic that may be incurred over the course of the calendar year.

Although not a fully exhaustive list, a consumer might typically incur the following monthly and periodic expenses over the course of a calendar year:

Monthly rent / mortgage payments;
Monthly debt obligations (i.e., credit cards, overdrafts, personal loans, etc.);
Utility Bills (i.e. electricity, electronic communications, water, gas, etc.);
School fees and associated expenses;
Groceries and household expenses (i.e., land tax, household appliances, etc.);
Motor vehicle related expenses (e.g. license, insurance, gas, etc.)
Insurance (i.e., home insurance, home contents insurance, motor vehicle insurance, life insurance)
Luxury expenses (i.e. vacations, dining out, designer clothing, etc.)

When making your list of monthly income, expenses and debts, Consumer Affairs advises consumers to take note of the following details of each expense:

Who you owe the money to (i.e. your “creditor”);
When your payments are due (i.e. first day/last day of the month);
When you have missed payments and when you paid for late payments;
How much you owe;
Your account or reference number; and
What the creditor has done to get the money back (i.e. sent you letters asking for payment threatening legal action or have taken you to court and received judgement against you, etc.).

The gathering of such information will enable consumers to draft a payment schedule for the calendar year which states which expenses are to be paid when. By taking note of all expenses incurred on a monthly and calendar basis, a consumer will be able to: (i) identify the amount of money they save on a monthly basis; and (ii) assess their personal financial security and how long they would be able to continue to pay their monthly expenses should they lose a source of monthly income.

Furthermore, by identifying which expenses are luxury expenses and which are necessities, consumers will be able to quantify the amount of outgoing cash going towards frivolous spending.

Although luxury spending maybe considered a “treat”, it is possible that excessive luxury spending may impact your ability to generate of a “rainy day” savings account and compromise your pursuit of personal investment opportunities that may result in the accumulation of long-term wealth (i.e. the acquisition of a substantial personal asset, the acquisition of stocks, the pursuit of an entrepreneurial ambition, etc.).

Paying off expenses while saving for the future can be hard if you do not know where to focus your energy. Making sure that you are earning more than you are spending is priority number one. If you do not have positive cash flow (i.e. you make less than you spend) this will compromise your ability to achieve your financial goals.

To help ensure that you have positive cash flow it is essential that you are aware of the difference between a “Need” and a “Want”. Distinguishing between these two types of expenses will help you prioritize your spending and align your monthly budget with the things that matter most in your life.

The human motivation theory developed by American psychologist Abraham Maslow proposed a five-level model of fundamental human needs; otherwise known as “Maslow’s Hierarchy of Needs”. Basic needs are the most critical and must first be satisfied before a person can advance to meet newer and higher-level needs. The basic human needs, in order of priority, are:

1. Physiological Needs: food, water, sleep, clothing and homeostasis.

2. Safety Needs: security, stability, freedom from fear, anxiety and chaos;

3. Belonging and Love Needs: giving and receiving affection, friendships, intimacy and family;

4. Esteem Needs: need for self-esteem and the esteem of others; and

5. Self-actualization Needs: the realization of one’s full potential.

Higher priority needs (i.e. physiological needs) must first be met before seeking to address lower priority needs (i.e. self-actualization) or satisfy unessential wants (i.e. luxury items, vacations, brand new car instead of second-hand car, etc.).

Fortunately, Maslow’s Hierarchy of Needs can be effectively applied to fiscal literacy and monthly budgeting as it can be used to help guide a consumer in their consumer decisions and ensure that essential financial obligations are budgeted for first.

To make certain that your priority, physiological needs are addressed, Consumer Affairs advises consumers to prioritize the following monthly expenses when developing your monthly budget:

1. Food;

2. Water;

3. Clothing; and

4. Shelter

Once your physiological needs are satisfied, consumers are then recommended to prioritize payment for expenses that are directly associated with ensuring their safety:

1. Rent;

2. Mortgage;

3. Insurance;

4. Expenses related to your employment; and

5. Social utilities (i.e. electricity and electronic communications).

Once a consumer's safety needs are addressed, their remaining monthly income can then be used to address lower priority needs associated with “love and belonging” and “esteem”. Expenses commonly associated with "love and belonging" and "esteem" are typically considered “luxury” expenses or “wants” and include, but are not limited to:

1. Gifts

2. Travel and vacations;

3. Entertainment and Dining Out;

4. Fitness and gym memberships;

5. Luxury spending;

6. Hobbies; and

7. Charitable contributions;

Consumer Affairs appreciates that you may agree or disagree with the categories and prioritization of certain types of expenses, but it is important to appreciate the underlying principle of prioritizing your needs over your wants and luxury spending.

If you are aware of the fact that you owe money to a creditor (i.e. a provider of a consumer good/service who you have not yet paid in full), Consumer Affairs recommends that you contact your creditor and communicate that you want to pay off your debts through installments (i.e. periodic payments) as part of a voluntary repayment plan.

In addition to communicating a desire to enter into a voluntary repayment plan, Consumer Affairs advises consumer to request their creditor(s)to:

Refrain from proceeding with legal proceedings in order to reclaim the outstanding debt so long as the voluntary repayment plan is complied with;
Confirm all details associated with their debt(s);
Withold further correspondence related to repayment of the debt so long as the voluntary repayment plan is complied with; and
Withhold applying further interest and administrative charges to the outstanding debt.

As part of the negotiation of a voluntary repayment plan, consumers are advised to propose a realistic repayment plan that they will be able to consistently meet while still being able to pay their other on-going monthly expenses on time (i.e. avoid falling into arrears and accumulating debt elsewhere).

Once you have agreed to a repayment plan with your creditor(s), Consumer Affairs advises that you send a follow-up letter or e-mail outlining what was discussed and what was agreed to (i.e. downpayment and/or repayment schedule). This written communication will serve as evidence that formal repayment agreement was entered agreed to in the event a creditor decides to refer your debt to a debt collection agency and/or take you to court.

If you decide to not contact your creditor(s) to discuss your financial circumstances and negotiate a repayment plan for your outstanding bills, your creditor(s) will likely transfer your outstanding debt to a debt collection agency or pursue legal proceedings themselves. If your debt is transferred to a debt collection agency, it is important to note that in addition to having to repay your debt you will likely incur additional costs, including administrative fees, legal fees and interest.

If you hold a debt with a utility provider (i.e. One Communications Ltd., Digicel or the Bermuda Electric Light Company), and find yourself unable to repay the debt in full, Consumer Affairs advises consumers to contact your utility provider and negotiate a voluntary repayment plan. A voluntary repayment plan will allow you to:

Repay any debt you owe through extra monthly payments;
Continue to pay towards your monthly bill; and
Continue to obtain the benefits of the services being provided (i.e. mobile phone plan, residential electricity).

It is at this stage Consumer Affairs advises consumers to exercise caution when contacting creditor(s) to negotiate a voluntary repayment plan. If the voluntary repayment plan is too aggressive (i.e. unrealistic in light of other on-going monthly debts), this will likely result in the initiation of court proceedings and further costs being incurred and added to the outstanding debt.

Furthermore, if a consumer knows they have held a debt with a creditor for an extended period of time and the creditor has not actively forced repayment. With respect to civil claims the statute of limitations restricts the time within which a creditor may take a debtor court to force repay a debt. For civil debts the time limit to pursue a claim is 6 years.

If you know you hold a debt with a provider of a consumer good and/or service and have not received a letter before action and/or court documents (i.e. Ordinary Summons) within 6 years of the debt accumulating, your creditor will be time barred from pursing legal proceedings.

However, if you contact your creditor after the time limit for them to pursue repayment of the debt has passed (i.e. 6-year limitation period to pursue a civil claim and obtain judgement) the time limit for your creditor to pursue legal action against you restarts. By contacting your creditor to discuss repayment of an outstanding debit this is considered an acknowledgement of debt.

However, should a creditor pursue legal proceedings within 6 years of the debt being incurred and the creditor receives judgement in court, the creditor will have the ability to enforce that judgement decision for up to 20 years (i.e. re-list the judgement in court). As a consumer it is important to be mindful of the fact that each time a creditor re-lists a judgement in court (e.g. a debtor has failed to comply with a repayment schedule) the 20-year enforcement period restarts.

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Most people at some point in their life will need to borrow money from a financial service provider and/or a personal lender in order to:

Pursue the purchase of large assets (i.e. motor vehicle, home);
Finance educational endeavors;
Provide financial relief when faced with a personal emergency; and/or
To fund a special event (i.e. weddings, birthdays, etc.).

If you are considering borrowing money, potential borrowers are advised to have an open and honest relationship with their financial service provider and/or personal lender and communicate if and or when they face changes in their personal financial circumstances (i.e. a life event has compromised their ability to comply with an agreed repayment plan has been compromised).

It cannot be overstated how important it is for a borrower to have open and honest dialogue with their lender. Doing so will afford the borrower and the lender the ability to creatively negotiate a financial solution which affords the borrower a form of financial relief that specifically accounts for the borrower's individual circumstances.

Failure to communicate with your financial service provider, particularly in instances where you are finding it difficult to repay any monies borrowed, could result in you facing limited financing options and/or the possibility of losing any assets that have been held as collateral to secure the loan.

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There are many different types of ways to borrow money, whether it be through a personal lender or a financial service provider. Before agreeing to a formal lending agreement Consumer Affairs advises consumers to shop around in order to educate themselves about the different options available to them.

Given the impact borrowing large sums of money will have on a consumer and the way in which they will actively manage their personal finances over the course of the term of the loan, it is important to take all reasonable steps necessary to ensure that you make an informed financial decision and ultimately choose a financial product that best suits your needs (i.e. pricing and interest charged, security required, flexibility in the terms and conditions of borrowing, etc.).

The purpose of this section is to discuss the various types of credit/personal borrowing options that maybe available, their key product features (i.e. pros and cons) and important lending terminology used by financial service providers when seeking to secure their lending activities.

A consumer will typically secure a personal loan from either a financial service provider or personal lender to facilitate the purchase of a high-priced consumer good and/or service. The amount borrowed is typically subject to an interest rate and the outstanding balance (i.e. principal amount borrowed + interest applied) is repaid pursuant to an agreed repayment schedule (i.e. monthly instalments) over an agreed period of time (i.e. the term of the loan).

The reason that a financial service provider or personal lender will apply an interest rate to the amount borrowed is so that they may generate a profit for extending such a service and account for the risk of lending money (i.e. to account for the risk associated with the borrower defaulting on the loan and the administrative costs associated with gaining possession of any collateral held to secure the loan). When a lender extends a personal loan to a borrower it is common practice for the lender to apply a variable interest rate to the amount borrowed (e.g. base lending rate + 4.5%).

The United States Federal Reserve (the "Federal Reserve) sets the United States base lending rate for all financial service providers operating in the United of America. In Bermuda it is common practice for banks licensed and operating in Bermuda to set their base lending rate in accordance with that set by the Federal Reserve. As a borrower it is important to note that if you secure a personal loan that is subject to a variable interest as the base lending applied by your lender goes up and down, so will your monthly loan repayments.

Alternatively, depending on the strength of your personal financial circumstances and risk associated with borrowing your lender may elect to offer to extend a personal loan that is subject to a fixed interest rate. A fixed rate of interest is commonly made available to low-risk borrowers (i.e. high net wealth) that are capable of securing their personal loan through some form of high valued collateral (i.e. a pledge of cash assets, a chattel over your motor vehicle or home, a taxi license) and are willing to pay extra upfront fees for the certainty a fixed interest rate offers.

As a borrower you will usually be asked to make the repayments to your personal loan via direct debit from your bank account. If you do not make the payments on time, it is likely that you will be charged a late fee.

Appreciating the high costs associated with borrowing and the interest that is applied, it is important to remain mindful of the fact that your lender may be willing to afford you the option of being able to pay off the entirety of your personal loan at any time. Consumer Affairs suggests that you speak with your lender when you apply for a personal loan and look at the terms and conditions of credit agreement provided by your lender to confirm whether you can repay the personal loan in full at any time. A credit agreement is the document that you and your lender signed when you took out the loan.

It is important to note that although you may request your personal lender for permission to repay the entirety of your loan early, they may reject your request as lenders generate their profit based on the interest charged for borrowing. Allowing a borrower to repay their loan early will effectively result in the lender cutting into their anticipated profits.

Whether you are able to obtain a personal loan subject to a variable or fixed interest rate, personal loans can be secured or unsecured. It is important to note that any collateral offered to secure a personal loan may be at risk if the borrower is unable to keep up with the repayment schedule. With respect to an unsecured loan, although your house and/or personal assets are not immediately at risk if you fall into arrears, your personal lender can take court action to make you pay the money back.

If your loan repayment schedule becomes unmanageable (i.e. high risk of inconsistent or non-payment), or are struggling to repay a loan, Consumer Affairs advises that you contact your lender as soon as possible as you might be able to get your monthly loan payments reduced, amended (e.g. principal only, interest only) or paused. Your lender might agree to:

Reduce or stop charging interest on your arrears;
Be flexible with the amount you have to pay back and how long you have to pay it;
Allow you to pay a small amount or nothing for a fixed amount of time; and/or
Help you make a payment plan.

When negotiating an adjusted repayment plan Consumer Affairs advises that you think carefully about what additional payments you can afford; in addition to continuing to repay the original amount borrowed.

Consumer Affairs cannot undertake how important open communication with your lender is. If you fall on uncertain times, open dialogue with your lender will help them assist you during such times. Failure to communicate will likely render it difficult for a lender to consider financing options if you have gone too long without making a repayment or for failing to communicate the change in your circumstances sooner. If you decide to sweep your difficulties “under the rug”, this will likely result in making your life more difficult in the future.

Much like borrowing money through a personal loan with a financial service provider or personal lender, when you receive a credit card through a financial service provider you will have to agree to and sign a formal document called a "credit agreement". As a consumer it is important to note that "credit" is another term used to describe the borrowing of money.

A credit agreement is a legal document which sets out the terms and conditions upon which the financial service provider will be willing extend a line of credit to a customer (i.e. the amount of credit that is being extended, applicable interest rates, penalties, auto debit options, etc.).

A credit card is particularly useful for consumers that have consistent income as it affords them the ability to facilitate purchases prior to receiving anticipated income. Once their income is received consumers in possession of a credit card typically repay their credit card balance immediately in order to avoid incurring interest charges. Interest is applied to a credit card in the event the consumer has an outstanding balance (i.e. money borrowed) at an agreed date and time (i.e. the "due date" may be the middle or end of the month).

When a financial service provider approves a credit card you can spend up to your approved credit limit. The amount of interest varies between financial service providers and Consumer Affairs advises that you shop around for the best deal. If you go over your credit limit the provider may charge you an overage fee. Some financial service providers also charge an annual administrative fee.

As a consumer it is important to note that if you obtain a credit card and do not pay off the amount of credit used prior to an agreed date (i.e. before the end of the month) you will be charged interest on the amount outstanding, and the interest charged will be applied to the outstanding credit balance (i.e. the new outstanding balance). If this unpaid balance remains unpaid going into the end of the next period, the financial service provider will then apply the interest rate to the new outstanding balance. This is otherwise known as "compound interest".

For example, if you use your credit card which is subject to an 18% interest rate in order to facilitate the purchase a $100 item, and you do not repay your balance by the end of the month, you will be charged $18 in interest and your new outstanding balance will be $118. If the new outstanding balance of $118 remains unpaid at the end of, the 18% interest will then be applied during the next period you will then be charged a further $21.25 in interest. In this circumstance your new outstanding balance would be $139.24 (i.e. $118 +$21.25).

When extending this example over an extended period of time (i.e. 6 months to a year) it becomes clear how risky a credit card and “compound interest” may be for a consumer if not actively managed. It is at this stage Consumer Affairs advises consumers to be careful when seeking to obtain a credit card and to make deliberate efforts to repay their outstanding balance prior to the expiration of each billable period to avoid incurring unnecessary interest charges.

Where possible consumers are advised to enter into an "auto-debit" arrangement with their financial service provider. By providing your financial service provider with this formal instruction your outstanding credit card balance will be paid, either in full or partially, through funds held in another account (i.e. the account which receives any forms of monthly income).

Functioning much like a credit card, depending on your credit history and your ability to provide collateral to minimize the lender’s risk of extending a line of credit (i.e. cash held in a separate account, property, personal guarantees) your financial service provider may allow you take more money out of an existing bank account than what is currently there. This is called “going into your overdraft” or “going overdrawn”.

If your financial service provider allows you to overdraw on your bank account you will be charged interest (i.e. 18% on the amount overdrawn). Furthermore, like a credit card any outstanding balance will be subject to compound interest if you fail to repay the balance on a month-to-month basis.

For example, if you overdraw on an existing account to facilitate to the purchase of an item that is $100, and are subject to an 18% interest rate, if you do not repay your overdrawn balance by the end of the month you will be charged $18 in interest charges and your new outstanding balance will be $118. If this overdrawn balance of $118 remains unpaid at the end of the next period (i.e. at the end of the following month) you will then be charged $21.25 in interest. In this circumstance your new outstanding balance would be $139.24 (i.e. $118 +$21.25).

When extending this example over an extended period of time (i.e. 6 months to a year) it becomes clear how risky an overdraft and “compound interest” may be for a consumer if not actively managed. It is at this stage Consumer Affairs advises consumers to be careful when seeking to obtain an overdraft and to make deliberate efforts to repay their outstanding balance prior to the expiration of each billable period to avoid incurring unnecessary interest charges.

Although your financial service provider may have granted you permission to overdraw on an existing account it is important that you let your bank know in advance if you need to overdraw on your account (i.e. an “agreed” or “authorized” overdraft). An agreed overdraft may be for a fixed amount over a set period of time (e.g. $500 to be repaid within six months) or you may be given a limit on an ongoing basis to use whenever you like. If you have an agreed overdraft and are consistently unable to repay the overdrawn amount, in addition to charging interest your financial service provider might reduce or stop your authorized overdraft.

If you overdraw on an account without first obtaining approval from your financial service provider, this is called an “unauthorized” overdraft. If you attempt an unauthorized overdraft your financial service provider will usually return (i.e. bounce) any cheques you write, and other payments such as direct debits, from your account.

An unauthorized overdraft may impact your credit rating, the interest rate/fees applied will likely be higher than if you had obtained approval from your financial service provider and you will likely find it harder in the future to get a line of credit (i.e. a credit card, personal loan and/or mortgage). Consumer Affairs advises that if you find your personal accounts consistently being in an unauthorized overdrawn state that you contact your financial service provider and ask how they can help you.

It is recommended that you keep a careful account of the amount of money held in your account (i.e. the balance) and try to remember to review your bank statements as soon as they are first made available. If you think you might take out more than what is available in your account, contact your financial service provider immediately in order to negotiate the terms and conditions of a service agreement and avoid being in an unauthorized overdrawn state and having to face the associated financial repercussions.

A mortgage is a loan that is taken out to facilitate the purchase of a house and/or property. A mortgage typically lasts between 25 and 30 years and are paid back through monthly instalments. In addition to the repayment of the amount borrowed, mortgage lenders will apply interest to the amount borrowed. Interest is applied by the lender to ensure they generate a profit as a result of taking on the risk of extending the credit to the borrower (i.e. principal + interest).

Similar to a personal loan, the cost of a mortgage depends on the interest rate and whether the interest is fixed (i.e. interest applied does not change over the term length of the mortgage) or variable (i.e. interest rate applied may increase or decrease depending on the base lending rate applied by the lender at any point in time). In addition to acquiring a mortgage to purchase a home, if you have positive equity in your home (i.e. the value of your home exceeds the remaining balance of your mortgage) you can refinance your mortgage in order to facilitate home projects (i.e. renovations, extensions, etc.). This form of borrowing is typically called a second mortgage, second charge or further charge.

In addition to the application of interestcharges, if you take out a mortgage you are likely to be charged legal and administrativefees. Consequently,giving the binding nature of a residential mortgage and the associated feesConsumer Affairs advises consumers toshop around for the best deal before entering into a mortgage agreement with alender. Furthermore, Consumer Affairs advises borrowers to make sure that theyonly take out a mortgage they can afford and to consider the possibility of thevariable interest rate increasing and/or their financial circumstances worseningin the future. It cannot be overstated that the life of mortgage is a very long time and a lot can change during this period.

A residential mortgage in typically secured through some form of collateral, such as the home itself and/or additional personal assets held by the borrower (i.e. cash, existing homes/property, motor vehicles) and personal guarantees. It is important to remain mindful of the fact that if the home being purchased is used to secure your mortgage the bank retains ownership of your home until the mortgage is fully repaid. That in the event you default on your mortgage (i.e. consistent non-payment of agreed monthly payments), the lender has the right to repossess any collateral used to secure the mortgage.

If any collateral is repossessed the lender will then proceed to sell the collateral to facilitate the repayment of the mortgage. It is important to note that the lender is not obligated to ensure that any collateral sold is done so at fair market value and nor is the lender incentivized to do so if the mortgage has been secured by a personal guarantee. If there isa shortfall in the sale proceeds the lender will be able initiate legal proceedings and seek a court order obligating the borrower to repay the outstanding balance of the mortgage.

When determining whether it is favorable to extend a line of credit, a lender will ask for a series of personal information and supporting documentation indicating proof of your monthly income, expenses and debts. Lenders do so to ensure that the borrower can consistently meet the mortgage payments while paying their remaining living expenses. In doing so the lender will determine an appropriate level of interest that ensures a profit and mitigates the risk of the borrower defaulting on the mortgage.

Consumer Affairs emphasizes the need for borrowers to ensure that they regularly communicate with their lender; particularly when faced with possibility of experiencing financial difficulties in the near future. If you experience financial difficulties that compromise your ability to regularly repay the amount borrowed your lender will send you notifications of non-payment and communicate formal warnings of their willingness to commence legal proceedings and seek possession of the collateral held to secure the mortgage if you continue to default on the repayment schedule.

If you are at the stage in which you have begun to default on your mortgage repayment schedule (i.e. unable to consistently comply with the mortgage repayment schedule or not at all), the bank has issues formal warnings and has begun to commence legal proceedings in order to obtain possession of the collateral used to secure the mortgage, it is likely too late to negotiate a repayment plan and/or discuss refinancing options with your lender. For further guidance on mortgage management, please refer to the Debt & Finance - Mortgage Management page on the Consumer Affairs website.

Functioning much like a mortgage (see above), a home equity loan is a form of personal borrowing that allows a borrower to secure a loan using the positive equity they have in their home (i.e. through ongoing monthly principal and interest payments of an existing mortgage or by owning the home outright). Positive equity is when the market value of your home exceeds the amount of the outstanding mortgage.

For example, if a borrower’s home is worth $500,000 and the borrower owes $325,000 on the mortgage used to purchase the home, then the borrower’s positive equity in that home is $175,000 (or 35% equity in the home). Alternatively, if a borrower’s home is worth $550,000 and the borrower owes $600,000 (i.e. the remaining balance of the mortgage to purchase the home) then the borrower will have negative equity in their home and will likely be unable to qualify for a home equity loan.

Home equity loans can be used for a number of different reasons, including but not limited to:

Construction/Home Renovation Loans: A home equity loan may act as a source of financing for large home renovations (i.e. installation of an outdoor pool, erection of a single unit apartment attached to the primary home, etc.).
Home Improvement Loan: A home equity loan may be used to finance small to medium-size renovations, typically less than $100,000 (i.e. installation of new bathroom fixtures and fittings, installation of new windows or air-conditioning units);
Home Investment Loan: A home equity may be used to finance the acquisition of a second home which can then be used as a source of passive income (i.e. rental income property or vacation rentals); and
Home Equity Line of Credit: Similar to a credit card or an overdraft (see above) a home equity line of credit allows a borrower to borrow additional finances which are secured through the positive equity of their home. Interest is charged on monthly basis to the borrower's account. It is important to note that applicable interest rates for a home equity line of credit vary (i.e. are subject to change as the financial service provider updates their fee schedule) and there is a typically an annual fee that is applied.

Given that a home equity loan is secured through the positive equity in a borrower's home, the applied interest rate on a home equity loan may be more attractive than an unsecured personal loan. Unsecured personal loans are typically subject to higher interest rates. Additionally, the term of a home equity loan can be for a greater period of time (usually up to 30 years) than an unsecured personal loan (usually up to 5 years). Therefor the use of a home equity home has the potential to save the borrower money through lower interest payments and grants the borrower greater flexibility when negotiating a repayment schedule with the lender.

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If you decide to borrow money (i.e. personal loan, mortgage, home equity loan) your lender will conduct a risk assessment in order to determine how much money they can lend you in accordance with their internal lending and risk policies. As part of your lender’s risk assessment, your lender will take into account the following criteria:

Income, investment interest, commissions, and other verifiable sources of income;
Expenses and outstanding debts;
Debt-income ratio: which is combined debt and housing expenses, which should not exceed 50% of your monthly income.
If obtaining a home equity loan, your lender will seek to review at least two property appraisals conducted within two years of your loan application, to ensure its market value is sufficient collateral to support your loan; and
Credit history (i.e. your past debt record and your ability to consistently make payments toward paying off your debt);
Age (i.e. if you are 50 years or older, this will influence the length of the loan);
The size of the down payment you are able to make towards the securing the loan; and
Additional collateral (i.e. cash held, personal guarantees, joint & several guarantees, other property with value such as cars, boats, commercial and residential property).

As part of your loan application you will likely need to provide the following information and supporting documentation:

Completed application form;
Proof of employment and income (i.e. a valid employment contract or bank statements indicating monthly income);
Copy of cost estimate report from a quantity surveyor if you are considering home renovations;
Quotes from construction contractors if you are considering home renovations;
Proof of rent or existing mortgage payments;
Copy of a utility bill (i.e. electricity, electronic communications, water) dated within the last two months of the date you submit your loan application in order to verify proof of residential address;
A detailed copy of your real estate agent’s listing if you are seeking to purchase a home;
Satisfactory credit references;
Completed personal financial statement;
Proof of available security (i.e. title deeds on your home, motor vehicle, boat, etc.)
Valid Identification (i.e. driver’s license, passport);
Construction quote;
Approved plans in place;
Estimated market value upon completion of construction project, if applicable.

The above-mentioned criteria will influence your lender’s decision to offer you financing and the terms and conditions which may be imposed (i.e. your approved loan amount, the mortgage type, the size of your monthly payments, your mortgage interest rate, and the term length of the loan).

Financial service providers rely on a credit risk score system to decide how much risk is associated with lending to you. Each fact about you is given points. All the points are added together to provide the lender with a credit risk score. The higher your score the more credit worthy you are.

Financial service providers set a threshold level for credit scoring. If your score is below the threshold, they may decide to not to lend to you or to charge you more if they do agree to lend. Different lenders use different systems for working out your score.

It is important to remember that lenders are not acting in your best interest when offering you financing as they know they can likely rely on any collateral provided to secure the loan in the event you default on loan repayments.

Given the inherit risk associated with borrowing, Consumer Affairs advises potential borrowers to shop around for the best terms and conditions before agreeing to enter into a loan agreement with a lender (i.e. complete loan applications with at least three financial lending institutions and schedule an appointment with a qualified loan officer at each financial institution).

After shopping around with potential lenders and having review the terms and conditions upon which they intend to lend, Consumer Affairs advises that you conduct your own personal financial assessment and develop a monthly budget in order to determine whether you will be able to consistently make payments.

Once a loan application is submitted, pre-approval for a specified amount may be given if your lender considers your request to borrow low-to-medium risk. Pre-approval gives you the security of knowing that when you find your dream home you can act quickly on the acquisition. The process of obtaining pre-approval is typically free and are usually valid for three months; but you can apply for an extension with your lender if needed.

As part of the approval process, your financial service provider may consider imposing one or all of the following terms and conditions in your financing agreement:

Payments may be interest-only until construction is completed. This period may last up to one year;
There may be an initial fee (a percentage of the total borrowed) on the borrowed amount;
Terms and rates may be subject to change without prior notice;
Depending on the size of the loan, they may ask to meet with you and your contractor to discuss terms and conditions;
During the construction, they may visit your site; and
They may require a property valuation to be completed by a qualified appraiser.

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Once you have chosen the type of borrowing that suits your needs (i.e. personal loan, mortgage, credit cards, overdraft), Consumer Affairs advises that you look around for the best credit deal and get a few quotes so that you can compare the costs and other terms of the agreement.

If you are borrowing jointly with someone else, make sure you both understand all the terms and conditions associated with “joint and several liability”. If someone else agrees to secure your loan and pay the loan if you don’t pay it, they are called a ‘guarantor’.

Make sure your guarantor understands all the terms and conditions, including when they would have to pay the loan instead of you. For further guidance on the impact of joint liability please refer to the Debt & Finance – Mortgage Management page on the Consumer Affairs website.

Table of contents

Money management

Personal Budgeting

Borrowing Money and Credit

Types of Borrowing and Credit

Standard Lending Criteria

Borrowing and Shopping Around