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By Jonathan Chevreau
National Post
FP Money Section, excerpt
Saturday, November 17, 2001
Despite multiple cuts in interest rates by the Bank of Canada,
Canadians indebted to credit-card issuers and department stores
are still paying hefty rates of interest.
Average credit-card interest rates for standard cards issued by
Canada's six largest banks have dropped by only 2.7 percentage points
since their peak in October, 1990, according to the Canadian Banker's
Association.
In the United States, issuers limit how low their rates can go,
and most cards have hit an average floor of 14.5%. It appears to
be about five percentage points higher in Canada.
Depending on the product, the interest rate for credit cards at
American Express in Canada is 12.95% to 18.9%. That's up to 10 times
what you'd receive from the latest Canada Savings Bonds (1.8%).
Special introductory offers have rates of 5.9% to 9.9% for the first
six months of use of Amex cards.
The regular rate at Visa is 18.99%, according to Visa Canada Association,
while no-frill cards depicted as "low interest" charge
9.5% to 10.5%.
The rate at BMO MasterCard is 18.9% for the no-fee version. So-called
"low-rate" cards charge 13.9% interest on retail sales
(for a $15 annual fee), or 9.9% on cheques, balance transfer or
cash advances. BMO may lower rates in December.
The highest rates are at department stores, where rates still hover
close to 30%.
If you are one of the four out of five adult Canadians with credit
cards, avoid interest charges by paying off balances in full each
month. About 60% of Canadians do so and thereby get a short-term
interest-free loan.
Personally, I'd rather be debt-free altogether and collect interest,
or invest in bank shares and be a beneficiary of the spread.
If you're not fortunate enough to be debt-free, today's low rates
represent an opportunity to start breaking the shackles of debt.
The place to start is with the above-mentioned high-interest debt,
which -- unlike investment loans -- are not tax deductible.
Vancouver-based investment advisor Adrian Mastracci of KCM
Wealth Management says for those in the top 45% marginal tax
bracket, the non-deductible 18% rate of most credit cards will really
cost about 32.7%. You can do your own calculation for the 28.8%
charged by Sears Canada.
Norman Rothery suggests those with heavy credit-card and other
consumer debt consider a consolidation loan. "Here, credit-card
balances are transferred to a lower-rate bank loan. ING Direct lists
general loans at 6.5% plus, depending on the applicant's financial
position. This sort of thing may well require the cutting up of
credit cards," a good idea anyway.
Nonetheless, going from a 28% store card to 6.5% is a big saving,
and those with houses should be able to get an even better rate.
Using Mastracci's calculations, a loan interest rate of 6% really
costs 10.9% if it's not tax deductible or 3.3%, if it is deductible.
If you feel it's your duty to spend to keep the economy rolling
post-Sept. 11, consider buying a new car. The major automakers are
offering 0% financing.
If the price is the same as if you offered to pay cash, you'd be
silly not to take the four-year free money. But be careful to evaluate
the fine print of agreements when appliance or furniture stores
offer no interest payments for two years. Agreements with third-party
financiers may not let you pay off the loan in full once the payments
do begin in year three.
The other major debt is home mortgages. As rates fall, it's a great
time for young people to buy houses, or for older homeowners to
purchase a vacation or investment property.
Unlike in the United States, residential mortgage interest in Canada
is not tax-deductible. Most homeowners soon learn that the faster
they pay off their mortgage, the less interest they'll pay. This
is especially so in the early years of an amortization schedule,
when 90% or more of the payment goes only to interest rather than
principal.
Taking advantage of the annual 10% (or more) principal prepayment
can yield enormous savings down the road, as can increasing the
size and frequency of regular payments.
Those with mortgages up for renewal will enjoy improved cash flow,
but it may not be worthwhile to break an existing longer-term mortgage
and pay the penalty. Homeowners who opt to pay the IRD, or Interest
Rate Differential penalty, cannot win. It's like trading four quarters
for a dollar.
Thus, if you are paying 7% and are locked in for two more years,
breaking the mortgage to pay today's 5% rate would probably be a
wash.
However, a loophole at some banks may make it worthwhile to pay
the IRD. The Royal Bank, in an example where a $150,000 mortgage
at 7% has one year left to renewal. In that case, you may win by
taking advantage of the posted alternatives of a one-year open mortgage
at 5.4% and a closed mortgage at 4.6%.
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