In Debt: A Cautionary Tale

Here’s a little story about a gigantic bank.

A friend of mine has a mortgage for $260,000 on a house worth about $350,000, with one of the Big Banks. Her name is the only one on the title, but by agreement at separation, she will owe her ex $70,000 (most of the equity in the home) in a few months.

When she went to the bank to refinance when they separated last year, his name was removed from the title (so hers was the sole income repaying the mortgage), and she used her part of the equity (their mortgage was then $200,000) to pay off some old bad habits. Nothing too sinister: she’s self-employed and had accrued some back taxes, and she loves to travel.

The Big Bank not only approved the $260,000 mortgage for her solo, but they gave her another $20,000 line of credit, with a reasonable interest rate. When she first became self-employed four years ago, they gave her a $32,000 line of credit, with a crazy, credit-card-worthy interest rate of nearly 20%. Randomly throughout the years, this Big Bank, which also holds her LIRA, RESP and RRSP (the first of which is at about $60,000, and the latter two not worth much, at about $6,000 each), has offered her credit cards. She now has about $70,000 in credit with the Big Bank, in addition to the mortgage. Most of that credit is unused, except about $20K in consumer debt, which is not an enormous debt to carry on her income.

She recently decided she wasn’t going to buy him out, putting herself on a hamster wheel of earning, earning, earning, but rather would sell the house (maybe even to the ex) and buy something smaller in a slightly less desirable suburb.

And so she returned to the Big Bank, only to be informed that her financial circumstances — which have not changed one iota since they approved her for $260,000 and threw at her more credit — would permit a mortgage pre-approval in an amount that would not buy a bungalow in the suburbs of Tuktoyaktuk.

Time was, the Bank approved new credit based on actual monthly payment commitments; ergo, if you owed money on a line of credit that had an interest-only payment option, they considered the interest your monthly commitment.

Somewhere along the way, things changed, and the Bank now considers that monthly debt service costs are 3% of the total, regardless if you are obliged to pay that much or not.

Because her ex still owes $10,000 or so on another joint line of credit, they consider that she also must pay 3% of that total each month, even though a) she doesn’t pay it and b) an interest-only option is available on the account, making the monthly commitment actually only about $50. As far as they’re concerned, that’s another $300/month that isn’t available to her to service a mortgage.

She, naturally, was none too pleased. It was beginning to look like she was going to be renting for a while — after several successful years of self-employment, impeccable debt repayment to the very bank that says it can no longer help her, maintenance of a perfectly fine credit score and, granted, the accumulation of a reasonable amount of debt, but nothing excessive.

Now, I’m not advocating getting into debt, nor am I advocating staying entangled with an ex, no matter how amicable the split may be. What I am advocating is to stay on top of the changes that will affect you — maybe even read the contents of those envelopes that come from the bank every once in a while.

Remember that while you may be handling your debt load perfectly well, if it falls outside certain parameters, it may be problematic when it comes time to get financing. Generally, lenders want your debt:income ratio to be below 40%, and that includes your mortgage, taxes, heating, any vehicle payments, plus the cost of servicing your debts.

Hopefully my friend will get a happy ending. Her representative at the Big Bank is a nice guy, and she lives in what remains a “town” in spite of its proximity to the Big City. He’s helping her crunch some numbers, but what it all amounts to is a shell game. Pay this with that, borrow that for a few weeks and then put it back here, etc.

The Big Banks are your best friends when you don’t need them, e.g. you have lots of money already. When you need a little help? Not so much.

I think we’re in the waning days of banking dominance. Just like the phone companies, a monopoly is hard to maintain in the Internet age. There are now online possibilities for mortgages that don’t even have a brick and mortar presence. While their demise is certainly not imminent, I’d be only too happy to see homeowners migrating to some more creative financial solutions.

Remember, before you decide to buy a new home, make sure you can actually afford it!