Get Up to Speed on Your Financial Status

Polls often suggest that many Canadians don’t have a firm understanding about their finances and maintain some misconceptions about credit.

The Low Down on Credit To get a better handle on your debt, it helps to know how financial institutions calculate the charges on your monthly credit card statement. If you always pay the amount owed by the due date, you pay no interest at all. But if you carry over balances, there are differences in charges for various transactions: Cash advances and balance transfers carry interest from the moment you make the transaction. There is no interest-free period. Old purchases are unpaid transactions from a previous statement. On these, you are charged interest either from the date of the transaction or the date the purchases are posted to your account, until they’re paid in full. New purchases can be interest-free under certain conditions. The interest-free period has two parts: The time between the purchase and your statement date, and the time between your statement date and your payment due date. This grace period can vary from 19 to 26 days. Read the fine print when you take out a new credit card, use the ones you have, or take advantage of low introductory offers. Not knowing how your rates are calculated can cost you more than you realize. To protect your credit rating, many financial specialists recommend making the highest payment you can on credit cards, make all payments on time, and avoid signing up for multiple credit cards. Other information that is critical to maintaining a healthy credit standing includes knowing that: You are responsible for joint accounts and co-signed loans. Activity on those accounts shows up on your credit report. Paying off a negative record doesn’t completely remove it from your credit report. Collection accounts, late payments and bankruptcies can remain on your report for as long as ten years, even if the bills are paid off. Checking your credit reports will not lower your credit score and is a good way both to monitor your credit, find errors, and reduce the chances of identity theft. Changing old accounts can actually lower your credit score rather than improve it. When you close old accounts, you shorten your credit history and that can actually lower your credit score. If you want to close your accounts, start with the newer accounts to help preserve your long established credit history.

Among other things, surveys have shown that many Canadians don’t have a household budget and don’t know their credit rating, a key tool in managing finances and debt. Moreover, Canadians who have credit cards often lack such critical knowledge as the annual interest rate they pay on their most-used card and that credit reports contain information about every loan, credit card, line of credit, mortgage or fault of payment incurred. (Equifax Canada and TransUnion Canada will provide a free copy of your credit report by mail or online for a small fee.)

Moreover, sizable numbers of Canadians don’t consider the effect changing interest rates will have on their borrowing costs.

This lack of understanding along with certain misconceptions about credit can hurt your credit score, which determines your ability to borrow, cost you thousands of dollars in unnecessary extra payments, and hinder your ability to save (see right hand box for some of the common misconceptions).

Assessing Your Situation

Two tools are critical in helping you evaluate your current financial situation and, when prepared and reviewed annually, they can help keep you on track toward your financial goals.

With the help of your accountant, work up a net worth statement and a spending analysis. You may then also want to work out a budget.

The net worth statement lists your assets and liabilities. The difference between them is your net worth. The statement should include all assets including retirement plan balances, personal property, jewelry, and household items. Value the assets at the price they could fetch now.

Once the statement is prepared, review it with your accountant and discuss the following:

1. Your ratio of assets to liabilities: A ratio of less than one to one indicates you have more liabilities than assets and a negative net worth. If that is the case, talk to your accountant about steps to take to cut your liabilities. As your debt declines, the ratio should increase. Ideally, the ratio should be at least two to one or greater.

2. Net worth growth compared to inflation: Growth in your net worth should outpace inflation. If it isn’t, determine why and take steps. Otherwise inflation is just eating away at your net worth.

3. Good vs. bad debts: The amounts and types of debt you have weigh heavily on your financial health. Mortgages are typically used to purchase items appreciating in value and are generally considered “good” debt. Credit card balances and auto loans finance items that typically don’t appreciate and should be kept to a minimum.

4. Liquid vs. nonliquid assets:Nonliquid assets such as a home and other real estate, jewelry, and works of art may increase in value but be difficult to sell quickly at full market value. Liquid assets such as bank accounts and stocks are more easily converted to cash. You want enough of them to cover emergencies.

Once you have a handle on your net worth, analyze your spending patterns and identify ways to increase savings, if necessary.

Start with a cash flow statement that details all sources of income over the past year and all expenditures by category.

Divide the expenditures among:

1. Fixed and essential expenses (such as housing, insurance, taxes and savings),

2. Variable and essential expenses (such as food, medical care and utilities), and

3. Discretionary expenses (such as entertainment, clothing, and charitable contributions).

Cancelled cheques, credit card receipts, and tax returns can provide much of the needed information. If you are unable to account for large sums of money, keep a journal of all expenditures for a month or so.

The spending analysis could lead you to decide you need a budget to help guide you toward your financial goals. Points to consider include:

• Make conscious spending decisions. Don’t just assume you’ll spend the same amount as last year.
• Prepare a flexible budget. Unexpected expenditures are bound to happen and your budget should incorporate that possibility.
• Budget for large, periodic expenditures, such as tuition or insurance premiums.
• Don’t try to be too exact. All family members should have a reasonable personal allowance that can be spent without accounting for it.
• Periodically compare actual expenditures to your budget to ensure you stay on track.