Dealing with debt is a challenge many Canadians face. When asked in our recent survey how inflation is impacting their long-term plans, the most commonly selected choice was “focusing on debt reduction”. Faced with the rapidly rising mortgage interest rates of recent years, Canadians are among the most debt-burdened nations in the G7. Understanding how to manage, reduce, and ultimately stay out of debt is crucial for financial health. This post aims to provide straightforward advice for Canadians who are focused on a journey towards debt freedom.
How to Manage Debt
1. Assess Your Debt Situation:
The first step in managing your debt is to fully understand it. This means listing all debts, including credit card balances, loans, and lines of credit, along with their interest rates and minimum payments.
- Credit Cards: Note the balance and interest rate.
- Loans: Include mortgages, personal, and auto loans with their respective details.
- Lines of Credit: Don’t forget to list any open lines of credit.
Our Net Worth Calculator: Canada helps you easily add up your assets and liabilities. Once you have a clear picture, you can prioritize which debts to tackle first, which should be those with the highest interest rates or delinquency penalties.
2. Create a Budget:
A budget is a powerful tool for managing debt. It helps in allocating funds to essential expenses and debt repayment. The LARi Insight Family Budget Calculator can help you get started. There are various methods of budgeting; choose one that suits your lifestyle and stick to it.
- 50/30/20 Rule: 50% needs, 30% wants, and 20% savings/debt repayment.
- Zero-Based Budget: Assign every dollar a job, ensuring income minus expenses equals zero.
3. Negotiate with Creditors:
Don’t hesitate to contact your creditors to discuss your situation. You may be able to negotiate lower interest rates or better payment terms.
How To Get Out of Debt
1. Debt Repayment Strategies:
There are several strategies for paying off debt, including:
- Debt Snowball: Pay off debts from smallest to largest balance, regardless of interest rate.
- Debt Avalanche: Prioritize debts with the highest interest rates first.
2. Consider Debt Consolidation:
Debt consolidation involves combining multiple debts into one loan with a lower interest rate, making it easier to manage and pay off. There are a few debt categories that this approach applies to:
- Credit cards: You can consolidate all of your credit card debt onto one new credit card that offers an introductory promotional rate that’s lower than your other credit cards.
- Home equity: You can consolidate your various debts into one loan (likely at a lower interest rate) using your home as equity. This can reduce your interest costs, and make debt management easier and more straightforward, but it does come with an important risk – if you default, you can lose your home.
- A Debt Consolidation Loan: With this method, you apply for a loan at a financial institution. The loan should be sufficient to cover your debt obligations (credit cards, existing loans, etc.) so that you can repay those and focus specifically on paying back the debt consolidation loan. To explore monthly payments using different interest rates, try our Simple Loan Calculator.
3. Seek Professional Advice:
Consulting a financial advisor or credit counselor can provide personalized strategies and resources. Canadians can connect with a credit counselor for free through Credit Counselling Canada. If you work with a financial advisor, you can work with them on a debt reduction strategy.
How to Stay Out of Debt
1. Build an Emergency Fund:
An emergency fund can prevent the need to take on debt in case of unexpected expenses. Aim to save three to six months’ worth of living expenses. Our Emergency Fund Calculator helps you set a budget and saving target, or read our 10 Tips for Saving for an Emergency Fund.
2. Use Credit Wisely:
Responsible credit use is key to staying out of debt.
- Pay Off Balances Monthly: Avoid carrying a balance to reduce interest charges.
- Understand Credit Terms: Be aware of interest rates and fees associated with your credit accounts.
3. Continuous Budgeting and Monitoring:
Regularly review and adjust your budget. Monitor your spending habits and make changes as necessary to avoid falling back into debt.
Managing debt is a journey that requires diligence and commitment. By understanding how to manage, get out of, and stay out of debt, Canadians can achieve financial stability and peace of mind. Remember, it’s not about perfection but progress.
For more information, visit Financial Consumer Agency of Canada for resources on managing debt.
