Three client groups are vulnerable

According to recent figures from Statistics Canada, average household net worth had dropped to $184,300 from $185,500 in the second quarter of 2011. However, credit market debt — credit loans and mortgages — has reached an all-time high. The national debt/income ratio has crept over the 150% mark, meaning Canadians owe more than $1.50 for every dollar they earn.

It’s becoming increasingly important for financial advisors to talk to their clients about their spending habits and expenses before determining how much to put toward investments or insurance.

“You have to know the whole picture before you can even discuss things like suitability,” says Tom Hamza, president of Toronto-based Investor Education Fund, a non-profit organization that gives financial advice to consumers. Advisors, he says, must “understand the backdrop of debt, debt-to-income [ratio] and their clients’ ability to make decisions.”

Advisors should be aware that some types of households are more susceptible to debt accumulation than others.

Single Parents

According to StatsCan’s Canadian Social Trends report, released this past April, the average debt load of a single-parent household was $102,000 in 2009.

The average single-parent household has $2.27 of outstanding debt per dollar of pretax earnings — a debt/income ratio of 227%, compared with 170% for couples with children.

“The natural reason, of course is that there’s no pooling of resources,” says Rock Lefebvre, vice president of research and standards with the Certified General Accountants Association of Canada in Ottawa. “There’s no sharing of the rent or mortgage or car payments. You have to pool resources in this economy to get ahead.”

As a result, single-parent families have less to put into savings because they’re pouring their earnings into servicing debt. Says Hamza: “The stats show that [single parents] are paying more than 40% of their household income to maintain debt.”

Financially, it’s like living on a treadmill. A single parent may want to purchase property; but after years of paying rent and expenses, they are unable to build their savings.

“They tend to lease a car instead of buying a car,” Lefebvre says. “Or they’ll finance it for six years and find they’ll [eventually] owe more on the car than it is worth.”

Day-to-day living expenses also drag down single-parent households. Child care is the most significant contributor to debt for single-parent clients, according to Laurie Campbell, executive director of Toronto-based Credit Canada, a non-profit organization that helps consumers manage debt. Options for these households include getting rid of the nanny, finding a cheaper place to live, asking friends and family members for help or even going back to court to get more alimony or child support.

“It’s a tough group to address,” Hamza says. “These are situations in which ‘coupon clipping’ is not much advice to give. People are living beyond their means, but it’s hard to say that they’re doing it due to profligate spending; they’re doing it due to high expenses.”

It’s imperative that these families focus on paying off their debt earlier. According to CGA-Canada, single-parent families were the only category in which debt increased with age. The association’s research has found that 73% of single parents aged 19 to 34 had household debt, with an average debt/income ratio of 180%. The proportion of indebted single parents aged 50 to 64 is now 83%.

Once a single parent passes age 35, according to Lefebvre, paying off debt becomes harder. Those who are having their children later, Lefebvre adds, “are the people you’re going to see carrying mortgages into retirement.”

Retirees

Despite the widely held belief that no one should retire without a clean balance sheet, retired Canadians are increasingly struggling with debt.

According to CGA-Canada, 30% of indebted retired households have an average debt load of $60,000, while 17% have $100,000 or more.

“A large part of that [debt] is due to mortgages,” Lefebvre says. Reverse mortgages also have increased in popularity over the past five years, as have lines of credit.

“The home-equity line of credit is especially insidious,” says Gordon Pape, a fund analyst in Toronto and publisher of the Internet Wealth Builder website (www.buildingwealth.ca), “because you always have the money there.”

Unfortunately, current low interest rates aren’t helping. They are luring retirees into borrowing more. A reality check may be needed. Adds Pape: “People have to understand how vulnerable they are.”

One way to demonstrate the harsh consequences of borrowing is to show your clients how much it would cost to service their debt if the prime rate were to return to its pre-recession rate of 6.25%. For many clients, that would double the size of the minimum payments required to service their debt. Says Pape: “I don’t think a lot of people going into retirement actually crunch those numbers.”

Some indebted clients, including retirees, might benefit from downsizing their homes. But some advisors have had difficulty persuading retirees to sell the family castle.

“Downsizing [as a solution] is a myth,” Campbell says. “People live in their houses until they die. They’re living on a shoestring so they can hold on to their houses.”

Stephanie Holmes-Winton, an independent financial advisor in Halifax and author of $pent (Byler Publications Inc., 2011), says her average retired client has $200,000 of debt.

Holmes-Winton recently helped a retiring physician and her husband, a business owner, conquer a major debt load. Already in debt, the couple wanted to pour money into renovating their family home, then sell it in 10 years and move into a cottage. Holmes-Winton advised the couple to downsize immediately, moving to the smaller home without putting money into renovations.

Says Holmes-Winton: “They would have had to pay property taxes and utilities on a bigger house for 10 more years.”

Instead, the client realized she did not have to work longer to fund the renovations, and could pay for the cottage and move into it mortgage-free.

“Now, they owe about $500,000 less than they did,” Holmes-Winton says, “which means they service half a million dollars’ less debt.”

Another trend affecting retirees — as well as pre-retirees — is supporting adult children. In these cases, you need to break the news gently to your client that it’s time to draw the line and urge the children to become self-sufficient.

Holmes-Winton tells parents in this situation: “Go to your kids and show them how much debt you have.”

Most often, the children don’t realize they’re putting their parents into debt and into serious financial jeopardy. An open, frank conversation — sometimes with the advisor present — is necessary.

Recent Immigrants

Newcomers to Canada represent another group that is particularly susceptible to debt. In addition to new surroundings, many immigrants have to adjust to a new language, new social customs and a culture that encourages borrowing and spending.

Many immigrants from developing countries are unaccustomed to the use of credit and credit cards, says Tina Tehranchian, a certified financial planner and branch manager with Assante Capital Management Ltd. in Richmond Hill, Ont.

Even today, she says, the use of credit cards among immigrants is the exception rather than the norm.

When Tehranchian first came to Canada from Iran in 1990, she and her husband used cash only. When they went to open a bank account, they were taken aback when the bank manager urged them to take out a loan to help establish a credit history. However, Tehranchian understood the benefits of doing so and paid back her loan punctually.

Unfortunately, not all immigrants are successful at managing debt. StatsCan’s Canadian Social Trends report states that those born in Canada are 60% less likely to have a high debt-service ratio than those who are new to Canada.

Even some of Tehranchian’s clients who earn seven-figure incomes have “huge debt loads,” she says, because they haven’t adjusted to the concept of efficient borrowing. Tehranchian introduces all her clients to cash-flow worksheets, which can give her clients a clear perspective on both their spending habits and how those habits will affect their retirement and their survivors’ cash-flow needs.

“Getting a good handle on your cash flow,” Tehranchian says, “and being able to manage it properly are good defences against abuse of credit cards.”

But financial literacy is not the only hurdle slowing down immigrants. Some immigrant households will walk the same financial treadmill as do single-parent families.

Many immigrants are starting from scratch when they are already middle-aged. “They have to make a lot of decisions that people normally make in their 20s and 30s,” Hamza says. “Then, they assume higher debt levels because they’re starting out later.”

These immigrants may be searching for a well-paying job or undergoing job training while trying to keep a roof over their children’s heads but with relatively low assets. Like single-parent households, many newcomers to Canada will have to look for government subsidies or a family member’s financial support to help manage mounting debt.

“The challenge is that when you immigrate to a country in your 40s and 50s, you are set back [by] at least a decade, in terms of your financial status,” Tehranchian says. “You go back one to two decades, and you then have to catch up. It’s a catch-up game.”

All clients struggling with debt must understand cash flow and wealth management, Campbell says, and where credit cards fit in.

“Credit cards are not part of cash flow,” Campbell says. “They’re debt. End of story.”  IE