Smart Money: Control Your Debt
Debt is a fact of life. Sooner or later you’ll be borrowing money, and that’s not necessarily a bad thing. When we borrow money, we can do the things we want faster than we would otherwise.
But as with many things in life that we enjoy, you want to keep your debt under control. Because debt can ruin you.
There are different types of debt, and some debts can even be considered good debts. The best possible debt should be low-interest, have tax advantages and use the money to acquire an asset that increases in value. An example is an RRSP loan. These are available at low interest rates, you can deduct your RRSP contribution from your taxable income, and the RRSP should grow over time.
Not all three of these conditions have to be met for debt to be worthwhile. A mortgage is an example. The interest rate will be low and real estate will often go up in value. Usually you can’t deduct mortgage interest on your primary residence from your taxes, but we can’t always get everything we want.
But people don’t usually get into trouble with good debt. It is the bad debt that we need to watch out for. The worst debts have a high interest rate with no tax break and are used to buy something that is depreciating in value. Examples of bad debts abound, including buying things you don’t really need on a credit card that you don’t pay off at the end of the month. Do everything possible to avoid bad debts from the outset.
Regardless of the type of debt, a debt settlement strategy is worth it. The faster you settle your debt, the less interest you pay and the sooner you can use the money you spend on loan payments for something more interesting.
There are some relatively painless mortgage repayment strategies that are worth considering. Paying your mortgage payments bi-weekly, or setting your mortgage payment a little higher than the minimum, or making a lump sum on your mortgage can cut your mortgage by years and save thousands of dollars. Talk to your lender about your options for paying off your mortgage faster.
When you have bad debt, getting it under control is often your priority. It is difficult to get on with your finances when your cash flow is constrained by too many loan payments, and trying to increase your net worth when you have excessive interest expenses is usually problematic.
If you have credit cards that you never seem to be able to pay off, talk to your financial institution about a consolidation loan. You may be able to cut your interest rate significantly and get a more manageable cash flow.
A word of warning. A consolidation loan is a rescue, not a free pass. If you take out a loan to pay off your credit cards and then go back out and pick up your credit cards, that’s a problem.
Here are some ideas if you don’t know where to start. Focusing on paying your bad debt first and then working on paying off your good debt is often the optimal strategy.
However, sometimes we have to break things down into manageable pieces. If trying to tackle all debts at once is too much and there isn’t an obvious first choice as to which debts to prioritize, consider the snowball strategy.
The Snowball strategy involves focusing on your smallest debts first and making the minimum payment for everything else. Once you’ve paid your smallest debt in full, move on and focus on your next smallest debt. The idea here is that you are trying to reduce the number of debts you have, rather than reducing the interest expense or the time it takes to pay off each one.
Dealing with debt carefully can make our lives better. But when used ruthlessly, debt can be the anchor that pulls us down. Control your debts so they don’t control you.
Brad brain. CFP, RFP, CIM, TEP is a Certified Financial Planner based in Fort St John, BC. This material is prepared for general distribution and may not reflect your individual financial circumstances. Brad can be reached at www.bradrainfinancial.com.