Debt is probably the most common financial disease affecting Canadians. Not only does it mean you’ll pay unnecessary amounts of interest, you risk damaging your credit rating, not to mention hurting your health when the burden of owing too many people too much money starts to get stressful.
There is a lot you can do to reverse the situation, regardless of how deep in debt you are. The toughest step to take is the first one – admitting to yourself that there’s a problem. Once you’ve done that, you’re already on your way to becoming debt free. Here are some strategies that may help you get your financial head above water.
If you’re drowning in a sea of debt, the first thing to do is to shut off the taps. While it seems straightforward, ringing up more debt can become a habit. Put away your credit cards, stop drawing on your line of credit, put off buying that new car with a car loan, and start paying cash for everything.
Often, people mentally separate what they owe from what they’ve amassed. A classic example would be someone who owes their credit card company $1,200 but has $2,600 sitting in their bank account.
The difficulty with paying off debt is you don’t really seem to get anything for your efforts. Meanwhile, it’s reassuring to look at your bank statement and see that you’ve got a couple of grand socked away.
The problem is, you don’t. In the example above, just under half of that belongs to the credit card company.
To get around this mental roadblock, it helps to remind yourself of the rewards reaped by using your savings to get rid of debt. First, you’ll cut down on your interest costs. And that means, in the long run, you’ll have a lot more money to spend. Second, you’ll remove a big psychological weight from your shoulders. (You may not even have noticed you’ve been carrying it around).
There’s another way to look at it. What would you say if I could offer you an investment that paid a guaranteed return of 30 per cent – after tax? Probably something original like “Wow!”
Well, paying off debt can bring you exactly those kinds of returns. If you have a credit card balance on which you’re paying 15 per cent, and you pay it off, you’re saving yourself that 15 per cent charge. It’s the equivalent of making that much by using the money to purchase an investment, and it’s guaranteed. And that’s 15 per cent after tax, mind you. If you are in the 50 per cent tax bracket and were looking for a GIC that could guarantee you the same return after tax, you’d be in the market for a GIC paying a whopping 30 per cent.
All right, you’re sold on the benefits of starting to pay off your debts. But you can’t get started because you don’t have any savings to speak of.
Or do you? Often, people have money stashed away in various places – and forms – that they’ve forgotten about. Here are a few stones to look under.
Many people, particularly baby boomers, have life insurance policies with a cash value, often bought for them by their well-meaning parents. These policies often have such a small pay out that they wouldn’t begin to take care of your real life insurance needs. In most cases, you can borrow against these policies at an interest rate far below what you may be currently paying on your debts. If this is the case, you may want to take out a loan, and use it to pay off your debts. You’ll still owe the same amount, but you’ve effectively slashed the interest rate on what you owe. Further, if you have bought yourself sufficient life insurance in the meantime, you may want to consider cashing in the smaller policy for its cash value.
Sometimes, market-wise relatives give family members stocks or bonds. If you’re lucky enough to have been on the receiving end of such a present, put your sentimental feelings aside and consider selling the investment to get some cash. That thoughtful relative would probably approve of the financial wisdom of such a move.
If you have any equity in your home, you can use it as security to obtain low-cost financing to pay off other debts. For example, many financial institutions offer home equity lines of credit near or even at their prime lending rate. Often, this will be markedly lower than what you are currently paying on your debt, particularly if you have a car loan, or have outstanding balances on your credit cards.
Yes, credit cards are one of the easiest ways for people to burden themselves with debt. So why am I suggesting adding more of these dangerous pieces of plastic to your collection?
The interest rate you pay on credit cards can vary immensely. Retailer cards, typically at the top of the rate heap, are currently charging around 29 per cent. While much lower, regular cards still cost a good sum to feed, at an average of around 18 per cent. But a number of financial institutions offer low-rate cards – often with interest rates under 10 per cent. Make the switch, and you’ll cut your carrying costs by anywhere from 7 per cent to 19 per cent.
If you’re in debt in a big way, chances are that you owe money to a number of different people and/or financial institutions. In addition, you’re likely paying sky-high interest charges on at least some of those debts, particularly if you are carrying big balances on your credit cards.
If you could pay less interest, you’d have more money to chip away at the principal of your various debts. How can you cut your carrying costs? With a consolidation loan.
For example, if you have any equity in your home, you may be able to use it as security for a personal loan that would be at – or close to – your financial institution’s prime rate. That could mean a drop in the interest rate you’re paying on some – or a lot – of your debt by 10, 15, even 20 per cent.
Another great feature of consolidating your debts is it cuts down on the paper work. It’s a lot easier to send one cheque each month to one institution, rather than trying to keep track of a handful of creditors, much less trying to decide who should get what. You’ll also probably feel more in control, and will be more motivated since it will be easier to see the progress you’re making.
Debt is often a by-product of your spending habits. Analyse just where your money is going, and you may quickly find that a great deal of your debt is the result of over-spending on a few types of purchases. Getting a handle on where your money goes may also help you uncover areas where it is relatively simple to pare back your spending, and redirect that money towards paying down your debt.