When to use unsecured credit as a safety net
By Cherri Doucette, Senior Private Client Advisor 2 January 2020 3 min read
It's been said timing is everything. Whether the first person to utter that phrase knew it or not, it’s very applicable to cash flow management. No matter how well people are doing financially, cash flow management can still be challenging and, of- ten, it’s a matter of timing.
You know you’re going to receive the money in the near future, but you need to make the major purchase today.An unsecured line of credit gives you the security of knowing you can pay for major life events, investment opportunities, other assets, or take care of recurring expenses when you need to, without having to wait for the cash.
High limit unsecured credit is a proven cash flow management tool that’s been used by high-net-worth individuals for years. It’s a useful tool for people who do not have security to offer as collateral or who do not want to tie assets to a credit line.
Unsecured vs. Secured
When clients approach us with a credit need, we look at various ways of getting them access to credit. This could be through secured credit, unsecured credit or a combination of both. Most clients are sensitive to higher interest rates and prefer secured credit with a lower rate. Common factors in determining which route are time and cost.
The inability to provide security in a timely fashion directs us to look at unsecured credit. Conversations include exploring what the funds are for and how the client is going to revolve the debt. The required monthly payments on an unsecured line of credit are interest only; it’s then up to the client to make lump-sum payments over time, including significantly revolving the account every two years.
Eligibility for unsecured credit is determined by a client’s credit worthiness and debt serviceability, along with either a net worth or average annual income component.
Supporting documents used in this determination include appraisals, tax assessments, investment assessments, income tax returns, business financials and other supporting documentation. We also look to see what unsecured credit facilities are already in place with ATB and other financial institutions.
Sometimes clients have large incomes but little net worth. This can be common with young professionals just starting out in their careers. They might be making a lot of money, but they may also have a significant amount of debt. In these cases, we determine the client’s average annual income.
As an example, let’s take someone who is going to earn $500,000 in their first year on the job and $750,000 in their second year. We can offer an unsecured line of credit in an amount equal to 25 per cent of the average income of $625,000, which would equal $156,250.
This is a significantly higher amount than you can access at the retail level, where an unsecured line of credit typically tops out at $50,000. In fact, ATB does not have a dollar limit on the amount we can provide for an unsecured line of credit as long as the client meets our metrics and ATB is comfortable with the level of risk.
A Matter of Interest
Interest rates can be higher on un- secured lines of credit; however, this financial tool is not meant to carry a balance long-term.
Because there is a higher amount of risk in terms of having no security, we conduct an annual review of your financial situation. For lines of credit with lower limits, the annual review may just constitute a check with the credit bureau and most recent Notice of Assessment from the Canada Revenue Agency. For higher limits, we do full due diligence to ensure clients still qualify. If they don’t, we simply convert the line of credit into an unsecured five-year loan.
Cash Flow Freedom
An unsecured line of credit is meant to be put in place so that you can get what you want right away and we can figure out a payment plan later. After you make a purchase, you can talk to your advisor about next steps. That might mean rolling the line of credit into a five-year loan. In other cases, equity in the client’s home becomes available so the line of credit can be rolled into a home equity line of credit with a more favourable interest rate. Either way, this frees up your line of credit for the next purchase.
If you need credit to help manage cash flow but haven’t been able to access the amount you require, talk to your advisor. This financial tool may be exactly what you need to gain the ability to make purchases on your terms rather than waiting until the cash you’re expecting arrives.