Does your outstanding debt look like a numerical Godzilla? That can be a scary sight. How do you confront something that has grown into such an intimidating beast? Well, you are not alone. Millions of Canadians are in the same boat. Equifax Canada reported that Canadian debt was up 2.7% from 2018 to 2019.
The good news is, you’re already taking a step in the right direction by reading this article. Here are some simple strategies for effective debt repayment. Let’s get started!
What is effective debt management?
You might be wondering, “What is a debt strategy?”
A debt strategy typically refers to a plan or method for paying down or eliminating debt. This can include managing cash flow, debt consolidation, or insolvency.
An effective debt management strategy considers your unique situation, obligations, and needs. It's a carefully considered and comprehensive solution for resolving your debt in a way that places the least possible stress on you. It allows you to work towards your financial goals within a reasonable timeframe.
Things to consider when choosing a debt repayment strategy
Getting out of debt is something you can do yourself with the right tools and motivation. When picking a debt repayment strategy, it's essential to consider your level of motivation and dedication regarding your finances.
Answer some of these questions honestly. Are you someone who needs to see a quick win to keep going? Or can you focus on the bigger picture and stick to your plan for the long haul?
The answers to these questions are important and will drive you toward the debt repayment strategy that best suits your needs.
Five strategies for simple debt repayment
Strategy 1 – Pay off high interest debt first
This is called the debt avalanche strategy. Write down your total debt amount, not your minimum due. Also make a note of the other payments you’re regularly making; you’ll need to know how much you can afford to repay.
The goal is to optimize your debt repayment by paying the least interest in the shortest possible time.
Here’s an example of how your chart could look.
Credit Card 2
Credit Card 1
To start, make the minimum payments on all your debts. Next, put all your extra money toward the debt with the highest interest rate (in our example, this would be the $2,500 credit card at 28%). Once that's paid off, you move onto the next item (the $500 credit card).
Why it works
This strategy may be the most effective debt repayment method based on numbers alone. Knowing that you're choosing the most optimal path may be all the repayment motivation you need. As a result, this strategy works best for ultra-logical people who can stay the course without a quick win.
However, some people struggle with this method because it can take a long time to achieve your first complete debt repayment. Without a quick win, it can feel like you're not making progress fast enough, which some may find demoralizing.
Strategy 2 – Make a budget
Making a budget is the most important step in taking control of your debt. A budget is like a roadmap for your finances: it tells you how much money you have, where it comes from and where it needs to be allocated. Use this comprehensive budget planner with tips, guidelines, and live charts to show you where your money goes.
To get started, take these simple steps:
- Know where your money is going: Tracking your money will help you figure out what comes in and what goes out of your pocket. Every dollar you spend affects your overall budget.
- Evaluate your needs and wants: knowing the difference between your "needs" (something that is necessary, required or essential) and your "wants" (something that you'd like but don't necessarily need) is key to making a smart budget.
- Think about your financial goals: identify your short-term and long-term goals and make saving for those goals part of your budget.
Take budgeting one step further by exploring Statistics Canada’s Personal inflation calculator. Calculate your personal inflation rate based on the goods and services you use and learn how your spending habits compare to those of other Canadians near you.
Strategy 3 – Break it down
To use this method, simply review your debts and put them in order from the lowest balance remaining to the highest. Don't worry about which debt has the highest interest rate. For example:
Credit Card 1
Credit Card 2
The next step is to make minimum payments across all your debts to prevent penalties. Then, you'll want to put any additional money you have toward paying off your smallest debt (the $1000 credit card balance in our example). Once that's paid off, you move on to the next one.
Why it works
From a mathematical perspective, this strategy is not necessarily the most optimal way to approach your debt. However, for many people, this strategy helps them stick to their debt repayment plan.
Often, humans deal with large goals like debt repayment by breaking them into smaller, more manageable pieces. When you take on a manageable piece and succeed, it feels great. By knocking off that first chunk of debt, you feel like, "Yeah, I've got this."
If you're more concerned with trying to maintain the momentum needed to succeed in debt repayment (small wins!), this might be your strategy.
Strategy 4 – Stretch your dollar
Following a tight debt management plan can leave you trying to find ways to stretch every dollar. It is important to take a good look at your expenses to see exactly where you can save money.
First, look at your budget. Are there small things you can do to save and bring down recurring expenses? Solutions can be as simple as planning your meals for the week to save on food, planning your commute to save time and money on gas, or adjusting your thermostat to save on your energy bill.
Next, take a look at your fixed costs. If you're having trouble affording your fixed costs, talk with your provider or look into switching providers to get a better rate. Reducing those monthly costs could save you money over the course of a year.
For example, many Canadians find themselves paying too much for living expenses, such as their mortgage, insurance, utilities and more. The result is not having enough money to meet other financial needs.
If you're having trouble with your mortgage, talk with your mortgage lender and work together to try and find a solution. Likewise, you may be able to get a better rate for services such as home or auto insurance, telephone, television or Internet.
Strategy 5 – Consider consolidation
Learn about debt consolidation and whether it makes sense for you. You might be able to use a balance transfer credit card or a debt consolidation loan to roll multiple debts into one, ideally with a lower interest rate. Note that you’ll likely need a good credit score to qualify.
You may consider applying for a loan or line of credit to pay off multiple debts with high-interest rates. This is usually called consolidating your debts.
Consolidating your debts means you’ll only have to make one monthly payment rather than paying each of your debts individually.
A consolidation loan or line of credit may help you get out of debt if:
- it has a lower interest rate than the debts you are consolidating,
- it has a lower monthly payment than all your other debts put together as you can put the extra money toward paying down your debt faster
- you avoid taking on more debt with the available credit you free up
If you're considering a consolidation loan, make sure to ask your financial institution which type of debt you'll be able to pay off.
Be careful not to use the credit you freed with your consolidation loan. If you do, then you will have even more debt than before.
Paying back a consolidation loan
Making the minimum payment on a consolidation loan will help you get out of debt eventually. However, the minimum payment on a line of credit will usually only cover the interest you owe. You won’t get out of debt if you only pay this amount. Increase your payments to help reduce your debt faster and pay less interest.
A consolidation loan won't hurt your credit rating if you make your payments on time.
Eligibility for a consolidation loan
A financial institution doesn't have to provide you with a consolidation loan. To be eligible, you must have an acceptable credit score and enough income to make monthly payments.
Shop around for a consolidation loan
Be aware that some companies may offer consolidation loans with higher interest rates than the debts you are trying to consolidate. Make sure to shop around when you're trying to consolidate your debt.
Different financial institutions may offer you different interest rates depending on your product type. For example, you may pay less interest on a line of credit than on a consolidation loan.
If you shop around for a consolidation loan, make sure you do so within a period of two weeks so that it doesn't affect your credit score. Find out what questions to ask before you take out a line of credit or a personal loan.
Remember to periodically check your credit health
Your credit report and credit score are two of the main tools lenders use to determine whether or not you are a good candidate for credit products. Lenders want to know if you will be able to pay your bills on time.
Your credit score goes up and down based on the information in your report. For example: making regular payments on time will gradually increase your score, but missing payments will make it drop. In Canada, credit scores range from 300 to 900. Scores of 600 and over are good. Scores of 750 and over are generally considered excellent.
Why is a credit score important?
If you have a good credit score, you may be able to borrow money at a lower interest rate and pay less interest over the long term. A poor credit score can make it challenging to qualify for loans, credit cards, leases or mortgages and sometimes result in higher interest rates. Your credit history can also affect your eligibility for some debt repayment options.
Take time to check your credit health every so often. Check your credit report and ensure there are no errors in the report. Checking your personal credit report will have no effect on your credit score.
You have the right to know what information is on your report and can get a copy of your credit report free of charge.
Improving your credit score takes time, but there are many things you can do, such as using a secured credit card and making sure you meet all your minimum monthly payments. The Financial Consumer Agency of Canada has more advice on what you can do to improve your credit.
Now that you have a budget, have assessed and organized your financial situation, and put a plan in place, be sure to continue looking for ways to save money and spend smarter. These five strategies provide you with a basic path to improved financial security, but should you need more information, your provincial or territorial government provides resources to help you stay on track!
Before committing to any particular strategy or debt solution, speaking to an advisor can be extremely helpful. They can provide free, unbiased advice and debt counselling help. This can include discussing the specific types of debt you're dealing with, the particulars of your situation, and what your options are so you can find the best debt management strategy to fit your needs.
Reach out today to receive free debt help and get started on the path to becoming debt-free.