Ramping up debt repayment doesn’t necessarily have to derail long-term financial plans, some advisors say.Rene Mansi/iStockPhoto / Getty Images
Sign up for the Globe Advisor weekly newsletter for professional financial advisors on our sign-up page. Get exclusive investment industry news and insights, the week’s top headlines, and what you and your clients need to know. For more from Globe Advisor, visit our homepage.
With higher interest rates driving up the cost of borrowing for many Canadians this year, some clients have been turning to their advisors for guidance on how to prioritize debt repayment within their financial plans.
For many advisors, helping clients handle rising interest payments alongside their other financial goals has been an exercise of digging deep into their budgets while also exploring how they can best position themselves to weather further interest rate shocks in the near future.
In September, Equifax Inc. reported that Canadian consumer debt hit $2.4-trillion in the second quarter of 2023, with credit card balances reaching an all-time high. The rising cost of borrowing was also clear with minimum monthly payments on unsecured lines of credit climbing more than 18 per cent compared with the same quarter a year ago. Average payments on home equity lines of credit (HELOCs) also rose by more than $200.
Although debt reduction has been a topic of conversation with clients for years, many are now focused on paying down debt more rapidly, says Todd Neff, financial advisor with Edward Jones in Burlington, Ont.
“I’ve had some of those discussions with clients over the past probably six to 10 months as interest rates have started to get up there,” he says.
Discussions have ranged from paying down an outstanding vehicle loan of about 10 per cent interest to conversations about mortgages, lines of credit and HELOCs.
“While debt was very inexpensive, it was easy for households to spend more than they made. But that’s changing now and it’s making debt [repayment] front and centre,” he says. “It’s no longer feasible for some to just continue accumulating debt.”
Indeed, almost three-quarters of Canadians with debt are concerned about taking on more if high inflation continues into 2024, according to a recent Royal Bank of Canada poll.
When it comes to strategy, ramping up debt repayment doesn’t necessarily derail long-term financial plans, he says. Assets may only need to be drawn out of either savings or investments for debt with a very high rate of interest. Usually, all goals can be addressed in unison if clients have a good understanding of their cash flow.
“That strategy usually comes back to helping clients understand what their income and expenses are and how they relate to one another,” he says. “Then, often, it’s them taking that away and digging into the specifics about their expenses.”
Focus on spending habits
Similarly, Emily Rae, senior financial planning advisor with Assante Capital Management Ltd. in Halifax, is seeing the impact of higher interest payments on younger clients, with debt repayment now consuming more of their budgets.
“I was talking to a young client the other day – she’s the daughter of a client – and she got her first apartment and bought some furniture, and that interest payment was okay, but now it’s substantial,” she says. “If you don’t have a lot of bandwidth, you don’t have the ability to get out of that debt.”
Making the situation even more challenging is that traditional ways of reducing expenses, such as downsizing or purchasing a used car instead of a new vehicle, are not likely to result in savings in this market, she says.
When clients are ready to address debt, Ms. Rae takes them through a comprehensive budget exercise, looking at realistic ways to cut discretionary spending or increase revenue. As these clients are vulnerable to taking on further debt in the face of an unexpected expense, she also recommends they prioritize building an emergency fund.
“If your interest payments have doubled in the past year, where does that money come from? Sometimes, people think, ‘I have a raise coming,’” she says.
“Well, that might not fix the problem if you haven’t looked at it with your spending habits.”
Prepare for the future
Justin Prasad, financial advisor with BlueShore Financial Credit Union in Vancouver, says many clients who have debt are currently trying to hold on until interest rates improve.
“[Interest rates are] limiting their cash flow; or, if they had an emergency fund or investments, they’re having to think about paying down their mortgage now,” Mr. Prasad says.
As interim solutions, some older clients without debt have recently provided their adult children with lump-sum payments to service costlier lines of credit or variable-rate mortgages, he says. Others have also extended their amortization to give themselves some cash flow relief and ensure they aren’t disrupting their investments or savings. Mr. Prasad has also noticed significantly fewer people choosing to retire, compared with 2020 and 2021.
But while it’s primarily clients with variable-rate mortgages who are dealing with the effects of rising interest payments now, Mr. Prasad expects the debt conversation to be at the forefront for more individuals over the coming years.
Clients and advisors should be looking ahead to the potential impact of fixed mortgage renewals at higher rates in two or three years, stress testing these rates, and striving to pay down debt now, he says.
“Maybe you start focusing on paying down any sort of outstanding debt that you have instead of saving, so any cash flow you have can go and service the new mortgage rate,” he says.
“There has to be a lot of planning in place over the next three years.”
For more from Globe Advisor, visit our homepage.