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Financial planning tips

November 14, 2018

4 smart ways to protect yourself from credit card debt

If you carry a balance on your credit cards, what happens if you can’t make your payments – and what options do you have to keep that from happening?

Credit card balance insurance is sold as a way to be sure you can make your credit card payments if you lose your job or get sick – but it’s not the only way.

It can be convenient to buy credit card balance insurance when you get a credit card, but the coverage it provides can be costly and full of exclusions, and may only cover your minimum payments.  

What happens if I only make the minimum payment on my credit card?

If you just pay the minimum due on your card each month, the interest you owe will build up, potentially adding years to the time you need to pay it off and making your credit card purchases far more expensive in the end. 

If you don’t pay even the minimum, your credit-card issuer could send a collection agency after you. You could damage your credit rating, making it harder to get a loan or a mortgage, and you might even have trouble getting some jobs.

But illness or job loss can happen to even the most careful and responsible people. So what options do you have to protect yourself and your credit rating?

The first and simplest way to ensure you’re not carrying an unmanageable balance if trouble strikes is to make a habit of paying off your credit balance every month. That means only charging items you know you have money in the bank to cover, and not using your credit card as a revolving, high-interest loan. Then, if you find you do have to put a large or unexpected purchase on your credit card, like airline tickets or a major car repair, or if your ability to pay off your balance in full takes a sudden hit, your balance won’t be already bulging and it will be easier to clear it off in a short time.

It might sound old-fashioned, but financial peace of mind comes from living within your means, and putting a little money aside regularly in an emergency fund that you can draw on in, yes, an emergency, rather than having to hit the plastic.

4 tips to help protect yourself from credit card debt

Let’s say you’re working towards clearing your balance and being able to keep it clear every month, but you’re not quite there yet, and you want to be sure that you can make your credit card payments. Rather than focusing on what you’re insuring – your credit card balance – think about why you might need insurance – in case of unemployment, illness or injury.

1. Build an emergency fund

If you want to help make sure you can keep up with your credit card payments (and your other living expenses) if you find yourself between jobs or unable to work, an emergency fund is a good idea. Aim for a cushion of between three and six months’ salary, and consider keeping it in a tax-free savings account (TFSA). You can invest up to $5,500 per year in a TFSA, and put back whatever you take out in the following year, on top of that year’s contribution limit. Because you’ve already paid income tax on the money you put in a TFSA, you don’t have to pay tax on it when you take it out – and any investment growth inside your account is also tax-free.

2. Help replace some of your income with disability insurance

You may have disability insurance through a group plan with your employer, which pays you a percentage of your income while you are unable to work due to illness or injury. This will help you cover your living expenses, but you’ll probably have to draw on your emergency fund to make up the difference. If you’re self-employed, it’s vital to have adequate disability insurance through an individual plan.

3. Look into critical illness insurance

While Canadian government health insurance covers doctors’ and hospital bills, recovering from a serious illness can mean running up expenses for things the government doesn’t cover – like medications taken at home, transportation to appointments, housekeeping and child care, or lost income if a spouse or friend takes time off work to care for you. Critical illness insurance can give you a tax-free cash payment to spend as you wish, if you get one of the life-changing diseases or conditions your policy covers, after any required waiting period. You can also use the money from your critical illness insurance policy to help cover living expenses besides the illness-related ones – including your credit card bills.

4. Get good advice

Talking to an advisor can help you understand how you can use critical illness and disability insurance to help protect your family and your finances. An advisor can also help you make a plan to build your emergency fund.

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