The ABCs of cash flow planning: V is for Variable

Each week, we look at the ABCs of cash flow management.

V is for Variable

Many people don’t like paying variable interest rates on large debts, such as mortgages, since they prefer to be shielded from rate hikes.

In fact, it only takes a moment to freak a client out about how much an interest rate change could affect her. Yet, that same client may carry high-interest credit cards and loans, which means she’ll pay significant interest over the lifetime of her debts.

Read: 4 rules for good credit advice

For example, her debt structure may look like this:

• $82,000 mortgage at a fixed rate of 3.25%;
• $25,000 unsecured line of credit at 6.5%;
• $19,000 credit card at 19%; and
• $5,000 store card at 28%.

If this is the case, she’s currently paying more than 7% interest on her total debt (based on a weighted-average calculation). Still, if you suggest she’s paying too much, she may not agree since she’ll focus on her fixed-rate mortgage, which is perceived as safe and predictable.

Read: Majority say debt cripples saving

To help her lower her total interest rate, you need to show her the benefit of taking a different repayment approach. For instance, she could switch to a variable-rate open mortgage since those typically offer lower interest rates—so long as the benefits of switching outweigh any incurred penalties. Also, if suitable, she could choose a home equity line of credit over her unsecured line of credit.

Read: Canada’s homes get more expensive

If she’s able to structure her debts efficiently, she could free up cash flow that will help her pay them off faster.

Read: The ABCs of cash flow planning: U is for Unification

Still, when looking at restructuring debts, encourage clients to focus on more than interest rates. If they only consider the benefits of limiting exposure to interest rate volatility, they’ll fail to also take into account the total principals and amortizations of their debts.

To help clients consider all repayment factors, explain every possible debt structure. And when going through the cash flow planning process, offer comparisons of relevant repayment strategies.

Continue on to letter W.

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