Debt Reduction

Debt Free -- isn’t that everyone’s goal? Debt can be good and bad, but the key to managing your debt is keeping track and having a plan to pay it off. 

We may need to borrow money to buy large items like homes, cottages, businesses and investments. These are called secured debt because the money is used to buy an asset and that asset secures the loan. Since most of us do not have $400,000 dollars in a bank account ready to buy a house, this debt is considered good debt and the interest is typically lower.

We also have other types of debt called unsecured debt such as credit cards, personal lines of credit, car loans, student loans or outstanding income tax. These debts have higher interest costs because they do not have an asset attached to them. Sometimes these types of debts can accumulate and cause stress. This would be what we consider bad debt. Debts in this category are the ones you want to pay off first.

Where to Start

A strategy for repayment should be created that works best for the borrower and the type of debt they have.

There are three basic strategies for reducing your unsecured debt:

• The snowball method: This method focuses on paying off the smallest debt first. The goal is to reduce the number of creditors and to provide the debt payer with a sense of accomplishment that will help keep them motivated. Like a snowball, the effects of each payment are small at first, but as they pay off debt and eliminate creditors, they can then allocate the savings to the next smallest debt, which compounds the impact.
• The avalanche method: This method aims to reduce the amount of interest paid and therefore increase the amount of debt payment that goes towards principal.
• Debt consolidation: Debt consolidation can be a great tool for individuals with multiple creditors that are serious about repaying debt. You may want to consider applying for a loan to pay off multiple debts with high interest rates. Consolidating your debts means you’ll only have to make one monthly payment instead of paying each debt individually.

Special considerations

While the three debt strategies focus on debt reduction, not all debt is created equally and may have special status that could make paying it off less advantageous -- even if it has a higher interest rate or is a smaller value. For example, some student debt comes with an interest-free grace period of six-months where no interest is charged on the loan.

It is important that those who take on debt, read and understand all the terms associated with the debt vehicle, to avoid violating the terms, which could result in a performance-based pricing – higher than usual interest rate.

Creditor insurance is also an optional financial safety net for you and your family. It can help you pay off your outstanding credit or loan balances or cover payments for a period of time if an unexpected life event happens, such as a critical illness, becoming disabled, or passing away.

What to do next

Getting control of your debt is an important part of your financial wellness. If you’re trying to pay down debt and need help, don’t wait too long. Be proactive and seek help before experiencing challenges. Talk to your financial advisor. Paying off debt and limiting the amount of new debt will mean more money is available in your monthly budget for things like increasing your pension savings.

Remember that our Retirement Information Consultants are here to help you understand your personal situation and how each decision fits into your overall financial plan. Email ric@plannera.ca to set up an appointment today.