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Getting through COVID – Part II (avoid perpetual debt)

April 9, 2020

In Part I, we focused on the data behind the COVID virus, what it is, how it is spread and some strategies you can implement to get through the pandemic.  In this part we’ll focus on the financial implications how it will impact consumers as well as some suggestions on what you can do to mitigate the impact on your finances.  At the end of the day, absent a crystal ball, we can only speculate on final outcomes and imagine various scenarios.  Detailed information is difficult to find as well as challenging to understand.

The financial response to the virus has evolved, and continues evolving, almost on a daily basis, governments have implemented physical distancing and isolation measures, laws have changed, old ones have adapted, and new ones have been written.  Some have long term implications and others are designed for an intervention specific, timeline.  One of the first fiscal responses by the federal government was to purchase $50 billion worth of bank mortgages, ensuring liquidity for Canadian banks.   Maintaining financial institutions is unquestionably important, and something needed to be done quickly, but perhaps there may have been better choices.  The mortgage acquisition strategy is from the Harper government’s playbook circa 2008, and it might not have been the best solution at that time either.

Another mortgage-based solution is to allow homeowners to defer payments on bank mortgages for up to six months.  Some alternative, non-bank lenders, have also come on side with this strategy and it has been reported that over half a million applications have been made as at this writing.  That’s a lot of mortgage deferral requests and we’re only into the first two weeks, undoubtedly, many more will follow.  A caveat, deferrals are short term solutions with long term consequences. Deferals provide no relief for non-traditional mortgages such as secured lines of credit, with mortgagors already making interest only payments.  Many high-risk borrowers, who have obtained first, second or even third mortgages from “B” and “C” tier (private) lenders, are also paying interest only, leaving them with no cash-flow benefit.  Deferrals appear only to apply to the principal portion of the monthly payment resulting in longer repayment terms or a lump payment at the end.  The consequence is that there will be a significant amount of additional interest over the life of the mortgage, unless the mortgagor is able to make larger payments as finances return to near normal.  Banks will ultimately record larger receivables and still receive cash flow from interest payments. 

Some short-term, individual, aid packages appear to be vote-buying, smoke and mirrors type stuff.  The government has been churning out programmes, and modifications, in rapid succession, often before each one has been fully digested.  Too many, involve either adding more debt or postponing payments including tax, student loan and other government debt payments, albeit without penalty for short terms.  People are very anxious about their finances and some are pouncing on these offerings while others are taking a more cautious approach for fear of later audits and penalties for errors and omissions in their claims.  

A few of the programmes seem to make little sense, even though they do help the needy.  For example, the one-time HST rebate for low income families – some of whom, were financially unaffected by the crisis.  Similarly, the $300, per child, one-time CCB payment will be a carpet strategy payable to all CCB recipients, many of whom where not directly (financially) impacted through loss of employment.  One-time payments for recipients of welfare and disability support programmes, make little sense beyond currying favour at the polls.  Nonetheless, these poorer Canadians will certainly benefit from the boost, even if for only one month.   The CERB is a positive step for people laid off but caught between not having enough work-hours logged to claim EI and facing the prospect of paltry welfare payments.  I’ll repeat this mantra throughout this blog; read the fine print

Some student loans will have a new six-month interest free period – it doesn’t say payment free period, just interest free, yet even with fully deferred payments there is no real relief.   The debt is temporarily sloughed off to readdressed in the future.  In any event, these provisions only apply to people who are up to date on their student loan repayments and not those in arrears.  To the government’s credit it has allocated much needed funds to homeless shelters and women fleeing abusive domestic environments both of which are commendable under any circumstances.   Domestic violence has increased substantially since the lockdown first started, and homeless shelter beds have been in short supply for years as poverty has increased across Canada.  Individual and business axpayers are able to file later than the usual cut off date(s) and defer making payments of taxes due, without late filing or payment penalties and interest kicking in. 

Credit Reporting Agencies have advised consumer debtors to resolve delinquency issues directly with their creditors in order to preserve their credit ratings.  While trying to assist debtors in understanding how delinquency impacts them, Credit Reporting Agencies are of little direct help since their clients are the lenders.  Although consumers obsess over credit scores, keep in mind they are only useful for people who are seeking debt.  People with assets and who are able to manage their cash flow can usually get through life without debt and a low credit rating has little or no significance.   A high credit score simply tells lenders that you are in debt, you are using debt and you are not defaulting on debt payments.  A high credit score doesn’t imply that you are paying debt down or even managing debt appropriately.  And, a high credit score will not necessarily help you get a loan, of any kind, if your debt service ratio is over-leveraged.  Trans Union reported that 70% of bankrupts had strong credit scores. 

Small businesses can apply for a smorgasbord of tax and loan deferrals as well interest-free loans with a forgiveness element.  Banks are also rallying to provide more debt to struggling business owners in order to “maintain solvency”.  This loan regime benefits the lenders while deepening the problems already faced by small businesses.  No government has a history of small business philanthropy and any businesses contemplating these relief packages should carefully read the fine print.  Businesses and consumers applying for temporary relief programmes have already been cautioned that strict proof of their financial eligibility may be required and there will be serious, aforementioned, consequences if a later audit reveals the criteria was not met.  If false or erroneous claims are deemed to be fraudulent, following an audit, they may not be dischargeable in a bankruptcy or proposal proceeding.   So, make sure you carefully read eligibility requirements and only claim applicable benefits. 

Another government backed loan programme will provide up to $40,000 to businesses that meet eligible payroll criteria.  The details are not entirely clear, but it appears that up to 25% ($10,000) may be forgivable if the full amount of the loan is paid by the end of December 2022.   So, if you just borrowed the money you have 32 months to repay $40,000 in order to qualify for the 25% discount.  You’d better get busy because you need to pony up $1,250 per month.  Although not clear, it may be the case that if you miss a payment you can kiss the $10,000 discount at the end goodbye.  Notionally, this injection of money is to improve liquidity (another word for solvency) which is basically bank code for helping you meet your existing payment obligations.  Sadly, using debt to pay for debt has become a common practice in this country, lines of credit are used to pay credit card balances which in turn may be flipped from one card to another with lower interest creating the illusion of full payment, credit cards are used to buy groceries while pay cheques cover the interest payments on lines of credit which are eventually consolidated into mortgages so the cycle can continue.  Bankruptcy is traditionally considered “your last option” but it shouldn’t be, using debt to pay for debt should be the last option.  But I digress, if the loans are used for payroll or payroll related expenses the company may be taking on the additional burden of keeping non-productive employees on the books.  That may help government employment statistics, but soon or later there will be a reckoning.   If the funds are used to make payment on existing, interest bearing, debts there is still no advantage because debt is simply being used to pay debt.

Small business owners really need to get out ahead of the inevitable and start a conversation with their lawyer, accountant and a Licensed Insolvency Trustee.  Proposal provisions, under the Bankruptcy & Insolvency Act, are the best way to enhance cash flow, reduce debt and restructure businesses for continued operations.  LITs are federally licensed and regulated to provide you with better options than perpetual debt.  Borrowing money to make payments on already borrowed money is a vicious cycle that has no end.   Division One proposals make it possible to reduce almost all forms debt repayments including institutional debt, secured and unsecured debt, government obligations which may include CRA debt.  Restructuring your debt has tremendous advantages over simply deferring payments or struggling to repay additional loans.   In an ideal world the government would start cutting cheques to small business owners in a similar manner to the way they routinely do with corporate welfare recipients.

Consumers also find benefits in filing Consumer Proposals, that will reduce the face value of debt to pennies on the dollar.  By reducing credit card debt, and other debt payments to a single monthly payment it may be easier to stay on top of (important) mortgage payments.  Tax, and other government, debt can also be included in a Consumer Proposal.  It is important to stay ahead of what’s coming, act proactively to reduce debt rather than risk losing pensions, RSPs and Insurance monies.   Pride often drives people to procrastinate and self-liquidate before their initial meeting with a LIT and they are shocked to learn that they could have kept many investments and still found relief from debt.  Most LITs will allow you a free consultation to explore your options, make sure you don’t get sucked into the idea that the government will come up with a magic solution – they won’t and there isn’t one.  Remember, all government solutions come with a cost to the lowly taxpayer – you may pay now, or you may pay later, but pay you shall.