Tuesday, December 21, 2010

The Trouble with Debit Cards

If you’re like just about everyone around you and I’m sure you are, over the last 4-6 weeks you’ve been buying things for an endless list of people and trying to get it done as quickly as possible. More importantly, when you’ve found that perfect thing and taken it to the counter to pay for it, you’ve handed over a piece of plastic to cover the cost. We live in a society of instant gratification and the need for convenience. Unlike our parents or grandparents – who saved up for larger purchases – we are often tempted to splurge on bigger-ticket items simply because we have a debit card in hand when we head out “window shopping”.

And aside from overspending thanks to the advent of debit cards, consumers are also more likely to dip into overdraft, which ends up costing more thanks to fees and interest that banks charge whenever you spend more than you have in your account.

Basically, a debit card works like a cheque. The only difference is that every time you use it, you’re immediately taking money out of your account. That’s why when you overdraw it’s like bouncing a cheque – only worse because, unlike cheques, you probably don’t keep a record of every debit card purchase you make.

You may even make a bunch of small purchases before you realize you’ve spent more than you have. So before you pay for that coffee or lunch purchase with your debit card, make sure you have enough money in your account to cover it.

Revert to using cash for daily expenses...cash controls spending, plain and simple. Using cash to pay for everyday purchases such as coffee, transit, lunch and magazines alerts you to the idea that you’re actually spending real money. You just don’t get the same cautionary sense when you haul out plastic, be it a debit or credit card.

There’s a distinct cognitive event that happens when you handle money – it’s called awareness. Over the counter goes the five dollar bill and back comes a loonie, a dime, two nickels and four pennies.

Did you just add up the change above to determine how much money you have left? Did you think about what that purchase could have been? You see, you are much more conscious of this imaginary purchase than if you had paid with plastic.

Now, add in the awareness of the bills left in your wallet and you become attuned to your temporary wealth, or lack thereof. At the end of the day, what encourages or cautions many consumers about spending is knowing where you stand from a financial perspective. That’s why cash can help control spending. Using cash to pay for everyday purchases alerts you to the idea that you’re actually spending real money.

By allotting yourself a weekly cash allowance for entertainment and everyday expenses – such as that daily morning coffee or weekly movie – you are building a budget around what you can spend on these purchases. And once the money in your wallet has been spent, you have to ensure you fight the urge to withdraw more cash or resort back to using your debit card.

Be realistic about what you typically spend on these items in a week. If you routinely eat out for lunch or stop at Tim Hortons for coffee, count that as well. If you think you’re spending too much on these items, you can then decide to find a less expensive alternative, such as brown-bagging your lunch or making your own coffee.

Let’s say, for instance, that you start the week off with $50 in your wallet and you began to spend it on your purchases. You will see $50 turn into $40, $40 turn into $25, $25 turn into $15 and so on. Every time you look into your wallet, you will see what’s left over from your original $50 and be aware of how quickly your money is being spent. This alone can make you think twice before making a purchase.

Using cash instead of the convenience of debit and credit cards might seem like something out of the stone age but take a look at your parents and grandparents. They have likely never had large sums of debt they carried from month to month and have savings they should be proud of instead of embarrassed by.

Wednesday, December 8, 2010

Closing Costs – Often overlooked, always misunderstood

When buying a new home, closing costs are something everyone has to pay. Unfortunately, they often get overlooked and most homebuyers don’t understand what constitutes closing costs...maybe that’s why they get overlooked.

I think this has to do with lack of education and the fact that nobody really talks about what they are in detail, but rather just refers to them as “closing costs”. I remember when I bought my first house, the realtor didn’t talk about closing costs, the bank rep didn’t talk about closing costs and the lawyer didn’t talk about closing costs until a few days before the purchase was supposed to close and I was told I needed to produce several thousand dollars. What?! Now, of course I’m to blame as well since I didn’t seek out what costs needed to be covered and relied on the professionals I was dealing with to hold my hand through the process. Obviously that didn’t happen. I was naive, but most first-time homebuyers and some experienced homebuyers are too.

Fast forward 12+ years and you can understand why I highlight closing costs to clients at several points through the process. The last thing I want is for a client to be scrambling like I was a few days before closing, trying to cover their closing costs.

In reality, there is more to it than most would think. Here are some of the approximate costs that buyers should be prepared for:

- Legal fees of $1000-$1200 for the purchase with an additional $800-$1000 if they are also selling a home. This includes a title search, mortgage registration and discharge if applicable.
- $300 for a home inspection.
- $250 for an appraisal. In some cases lenders will require an appraisal to verify the market value of the property.
- PST on Insurance premium. If your mortgage is for more than 80% of the purchase price you will have to pay a default insurance premium, which is included in your mortgage. However, the PST on the premium is paid outside of the mortgage.
- Property tax to the vendor. If the vendor has pre-paid their property taxes for a portion of the year where you have ownership, you may be responsible to reimburse them for that portion.
- Land transfer tax. This is the biggie. There is an Ontario Land Transfer Tax and a Toronto Land Transfer Tax. Obviously buyers within Toronto are responsible for both and buyers outside Toronto are only responsible for the Ontario Tax. These taxes are tiered dependent upon the purchase price of the property. Land transfer taxes can add up. For example, the Land Transfer Tax for a $400,000 property within Toronto would be $8200 and $4475 outside of Toronto. A LTT calculator can be found here http://www.torontorealestateboard.com/LTT_splash/ltt_calculator.htm

Some of the above costs like the home inspection and appraisal would be paid for before the rest of the closing costs but I think they are worth noting since they are costs associated with the purchase that should be accounted for ahead of time.

You can see that closing costs can add up quickly. Most lenders use 1.5% of the purchase price as a ballpark estimate. Although this would give you an estimate of what to expect, I highly recommend doing a more accurate calculation. Knowing what your costs will be ahead of time will allow you to plan accordingly to have the money available or incorporate them into your mortgage if you can.