Why Canada's banks are wrong about emergency savings
September is survey season in the financial services industry. It gives the big banks an opportunity to shame and encourage us to get our financial houses in order.
Some surveys can really leave you scratching your head, though. Take the latest intelligence from Bank of Montreal that says just over half of Canadians have less than $10,000 socked away for emergencies.
It goes on to recommend we set aside three to six months income for emergencies like major car or home repairs, or job loss.
Three to six months income? Really?
Here’s an emergency: we’re drowning in debt.
According to Statistics Canada the average household owes more than $1.60 for every dollar it takes in each year.
Credit scorekeeper Trans Union reports the average Canadian has over $27,000 in consumer debt, which excludes mortgages.
The latest survey from the Canadian Payroll Association says 42 per cent of us live paycheque to paycheque, and 40 per cent spend all or more of our net pay.
With so many people struggling with debt it’s hard to believe BMO’s claim that nearly half of Canadians actually have $10,000 socked away for an emergency.
BMO’s advice is to keep that emergency money in its “Smart Saver” account, which currently pays out 1.1 per cent annually.
Time to crunch the numbers
What BMO is really offering after one year on that $10,000 at 1.1 per cent, compounded monthly, is $111.
During the same year, the bank can take that $10,000 and make $1,047 on a typical consumer loan at 10 per cent.
The point is; if you are that guy with the consumer loan you’re much better off using that $10,000 to pay down debt and saving $1,047 a year in interest payments.
Taking it a step further, a good chunk of consumer debt is balances owing on credit cards. Major credit cards like Visa and MasterCard impose interest rates in the high teens. $10,000 at 20 per cent generates interest of $2,194 after one year.
And then there are major credit cards sponsored by the big retail chains like The Bay that charge nearly 30 per cent on balances owing. At that rate applying $10,000 against the balance would save the card holder $3,450 after one year.
What about emergencies?
There are no emergencies if you are prepared.
According to the same BMO study 27 per cent of respondents have access to a line of credit. The interest rate on a line of credit can vary depending on the customer but it is possible to establish one at about 10 per cent.
Establishing a line of credit requires advance planning and a good credit rating with the bank.
In the event of an emergency coming up with the cash is as easy as an online transfer to a savings or chequing account.
Keep in mind you only take what you need for the emergency and pay interest on that amount – not the whole $10,000. With some discipline you can chip away at the amount owing and lower the total interest cost over time.
Customers with equity in their homes to back the loan get the best deal. A home equity line of credit can provide instant cash for as little as 3.5 per cent. Even if you needed the entire $10,000 for a full year the interest would only come to $356.
BMO isn’t the only bank to tout the need for an emergency fund. It is in the best interest of banks to get their customers to give them cheap money while charging the same customers more to borrow – and with interest rates on the rise, business is booming.