Thursday, 22 August 2013

One step forward, two steps back: 7 Simple tips to break the pattern and pay off debt

It seems like every week that goes by, I’m again reminded by the media that Canadian household debt is at an all- time high.  Although we’ve seen a fairly large reduction of debt -- about 2% -- this past quarter, the average Canadian debt load is still up 3% from last year. What we are now seeing is largely the effect of a push to give everyone free credit in the latter part of the last decade. One of the big reasons I left the bank in 2008 was that my bonus as a financial planner was directly correlated to the number of visas I sold; I did not want to be part of a machine that promoted people getting deeper into debt.This week, I’ve decided to put together some tips I’ve come across over the years to help people control their debt levels and pay them down.

Create a budget. First and foremost, if you are going to make a reasonable attempt to pay down your debt, spend some time making a reasonable budget.  Be realistic.  If you like going to McDonalds three times a day, include that.  If it’s important to you that you drink a case of Scotch a week, include it. The point of this is to create a baseline. After determining what you are spending, figure out how much money you are bringing in. Then it’s time to get creative. You should be able to see what you are spending money on that’s important to you and what what you are spending money on that isn’t. Then you’ll have some choices to make: either make more money, or fix some spending issues.

Freeze your credit cards. By far the best way to reduce your credit card spending (and I have done this myself) is to freeze your credit card. Literally. Take an old coffee can, fill it with water, and put your credit card in. Then, move it to the freezer.  If you feel the impulse to buy something, pull the coffee can out of the freezer and let it defrost.  By the time it’s done thawing out, 9/10 times the impulse is gone. Awesome trick.

Refinance. When you have a ton of high interest debt, and there is equity available in your home, you would have to be crazy not to use this equity to pay down the credit cards.   For example:You have a credit card with a $6500 balance on it.  The interest rate is 12% and the minimum payment is $130.  Because a large portion of that $130 is interest, you are only paying down your card by $65 a month.  As time goes by, and as you continue to make your minimum payments, your payments decrease – assuming you haven’t made any new purchases. When you hit a balance of $3000, your new minimum payment would be about $60, of which only $30 would be going to pay down the balance.  At this rate, the card will be paid off in about 27 years.Refinancing, on the other hand, will add the $6500 to your mortgage.  A $6500 mortgage at 3.39% for a 25 year term will cost you an additional $32 per month on your mortgage. Bump up the mortgage payment by the $130 per month you’re already paying anyway (ask me how) and it will be paid off in 4 years, not 27. Plus you’ll have paid a lot less in interest.

Switch away from revolving credit. The banks that grant you revolving credit such as lines of credit and credit cards fully understand that there is a very good chance you will be carrying a balance. The average Canadian’s debt right now is approximately $26000, mostly in revolving credit.  As there is a very good chance that, as an individual, you will maintain a balance for many years, the banks have no problem offering you a low interest rate. In fact, many banks will offer incentives for their sales officers to sell the lines of credit over conventional loans.  If you convert to a loan, the interest will definitely be at a higher rate.  But, there is a far better chance that it will be paid off when you plan it to be. 

Consider using your savings to pay off your debt. Many people have savings as well as debt.  If you are paying 12-18% on your credit cards, and have a high yield mutual fund that is paying you 9.5% per year, you are still losing money.   If you use your savings to pay down or pay off your credit cards, wouldn’t that be like getting a 12-18% return on your mutual funds?  It would also make it far easier to add money to your savings.Focus the majority of your attention on the debts with the highest interest first. Continue to make payments on the others, but understand that the sooner you get that 28% store card paid down, the more you can put down on other debts in the future. 

Change your buying habits. Shop on Craigslist or Kijiji more often. It will be less expensive, and 99% of the time it’s a cash only deal -- no extra debt build up.

Change your credit card type. If you have a Gold Card on which you are charged $120 per year, and the interest is about 18%, but you get Airmiles or other incentives, look at your balance. This card is fantastic if you pay it off every month. However, if you carry a balance like 80% of the population does, this card becomes fantastic for the lender -- change the card as soon as possible.  It’s just a matter of calling the call center and telling them you want to change to a low interest, no fee card.  You will never be able to collect enough points to justify carrying a large balance.Getting your debt under control is simple, but not necessarily easy. It takes time to change old financial habits and create new ones, but – as with all challenging tasks – is well worth the reward. And it all begins with the budget, which is something I can help you with; it’s part of what a mortgage agent does. It’s never a bad thing to have an impartial, outside perspective as it increases the chances of having a realistic budget – and therefore increases the chances of your making real progress on paying down that debt!

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