Breaking up the debt

Consumershave noproblem diversifying their assets like corporations do, but take a different tack whenit comes to diversifying their debts

The average Canadian has a personal debt that is at an all-time high — the ratio of household debt to income was 163.4 in the second quarter — so it’s logical to diversify to mitigate that risk. But we have an all-or-nothing approach to debt in this country that makes absolutely no sense.

Public companies, for example, don’t dare have all their debt come due in one year. They generally ladder their debt, with a certain proportion coming due every year. Consumers, on the other hand, get the idea of diversification on the asset side. They’ll buy a mix of bonds, real estate, growth stocks, dividend-paying investments — anything not to have all their eggs in one basket. But we almost fall into debt diversification by accident. Many Canadians will have an ongoing line of credit, a car loan spread out over a few years and then a mortgage. We won’t even talk credit-card debt, because no one should have that.

Finance professor Moshe Milevsky, who teaches at York University’s Schulich School of Business, says a mortgage is the best chance to diversify debt. “I continue to marvel by the small, small number of split mortgages; people go all fixed or all variable,” Milevsky says. “It comes down to banks just don’t put it on the menu. I don’t know why all the science that goes into asset allocation has not gone into debt allocation.”

A recent survey by the Canadian Association of Accredited Mortgage Professionals found only 7% of all people with mortgages used a combination of variable and fixed products. David Stafford, managing director of secured lending at the Bank of Nova Scotia, says it’s relatively easy to do a split mortgage. For example, the Scotia Total Equity Plan is a collateralized loan that offers flexibility on splitting terms. “To me, the conversation is the mirror image of the asset-investment side, except it’s a cost discussion versus a return discussion,” Stafford says.

Collateralized loans have been criticized because they don’t allow you to port a mortgage to another financial institution, but you can pay a fee to remove the charge on your home to set you free. Another issue arises if you have, say, a $500,000 mortgage — a third with a floating rate, another third with a rate locked in for five years and the remaining amount fixed at a rate for 10 — and one term is up while you’re still locked in for another. You’ll likely have to go with your existing bank and what it offers on the renewing portion of the mortgage or break it and pay the associated costs.

Certified financial planner Ted Rechtshaffen says reducing your availability to shop around might not be worth such diversification. “In theory, it makes sense to diversify your debt but the ability to shop your mortgage is more important,” he says. But Scotia, like many banks, says it will offer a competitive rate when part of that diversified loan comes up for renewal.

Ultimately, diversification might come with a price, but for people looking to mitigate rate risk, it might be worth paying.