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Financial planning tips

January 12, 2012

Four ways to lessen your debt load

Debt has definitely become the new four-letter word. Consider these four options to help get your debt under control.

debt load

Are you struggling to meet your financial obligations each month? These four options can help you ultimately become debt-free.

1. Consolidate your debt

Paying interest charges on several different credit cards and other loans? Call your bank and ask to consolidate all of these debts into a personal line of credit (LOC) or all-in-one account, at a lower interest rate. While the average credit card has an interest rate of 18% and department store cards have interest rates as high as 30%, an LOC’s interest rate is generally prime plus a percentage point (currently around 5%), says Rubina Ahmed-Haq, a financial reporter and blogger at Always Save Money. So rather than making payments to, say, three different credit cards, you’ll make one monthly payment to your LOC while simultaneously reducing interest costs.

Jim Yih, an Edmonton-based financial educator who writes a blog called Retire Happy suggests the only solution that works is to make more and higher payments to clear the debt as soon as possible. He adds that you can use a loan calculator to figure out how long it will take you to pay off your debt. “Calculate the loan over three, five or 10 years,” he says. “Many people will be shocked at how high the payments might be.”

2. Reduce spending

Quit purchasing items on the plastic. As Ahmed-Haq points out, debt consolidation is only a great strategy if you don’t add to your debt. “You’re not doing yourself any favours if you’re trying to get out of debt,” she says. “You need to concentrate on repaying it and stop charging anything to your credit cards.”

3. Watch your mortgage payments

Ideally, your mortgage and annual property taxes are no more than 30% of your after-tax monthly income, notes Ahmed-Haq. Yes, the bank may be willing to lend you way more money than that (Ahmed-Haq was offered a mortgage that to carry would represent 60% of her after-tax monthly income, for instance) but accepting that hefty amount of money will likely make it more difficult to pay your bills. “You have to ask yourself if you have taken on a mortgage that you simply cannot afford,” she says. “You may need to downsize or look at a less expensive house that you can afford.” Some people with smaller mortgages may opt to pay their mortgages off with a home equity line of credit (HELOC). They then pay down the HELOC, which allows them to make unlimited payments. But that strategy only works for disciplined people, since HELOCs also present flexibility in spending, Yih notes. “HELOCs have allowed people to live beyond their means and it’s so easy to give into the temptation of spending and consumption,” he says.

4. Write off liabilities

Run your own business? If you have accumulated some business debt, make that debt work for you. You could get a home equity line of credit or all-in-one account for your business income and expenses, and then write off the interest. If you want to adopt this strategy, see a tax professional to ensure your accounts are set up properly, says Yih. Still, he cautions that the best debt is “no debt at all.”

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