Are you struggling to pay your bills each month? You’re not alone. According to a recent report from Statistics Canada, Canadians owe $1.78 for every dollar they make. That includes credit-card debt, mortgages and other loans.
So, what can we do to dig our way out of this debt hole? Here are six small steps you can take towards ultimately becoming debt-free:
1. Consolidate your debt
Paying interest 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 bank-issued 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, says Rubina Ahmed-Haq, a financial reporter and blogger at Always Save Money. So rather than making payments on, say, three different credit cards charging 18%-plus for interest, you’ll make one monthly payment to your LOC at a much lower interest rate – which means you’ll be able to pay off your debt faster.
Jim Yih, an Edmonton-based financial educator who writes a blog called Retire Happy suggests making more and higher payments than required to clear your 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. Try the debt-snowball method
If you don’t want to consolidate your debt into one card, you can give the debt-snowball method a shot. Here’s how it works: You start by paying off the card with the lowest balance first while only paying the minimum on the others. Once the card with the smallest amount of debt is paid off, you can redirect your money to the next-lowest balance until it’s cleared. After that, it’s rinse and repeat until you reach the point where all your credit card balances have been cleared. Alternatively, you could try the debt-avalanche method, in which you pay off the card with the highest interest rate first. Whichever method you choose, you’re likely to see results very quickly.
3. Reduce spending and start saving
Do you often purchase items on plastic? As Ahmed-Haq points out, debt consolidation is only a great strategy if you don’t keep piling up more 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.”
But steering clear of plastic is only part of the solution. It also helps if you can watch your spending habits and look for places where you can cut back. Are there subscription services you’re paying for every month that you no longer use? Do you have a gym membership you never use? Are you spending too much on eating out? Or maybe you can find ways to save on home expenses, like taking advantage of time-of-use electricity rates or tweaking your water heater to curb your energy bill. The more money you save, the easier it’ll be to dig your way out of debt.
4. Watch your mortgage payments
Ideally, your mortgage and annual property taxes add up to no more than 30% of your after-tax income, notes Ahmed-Haq. Yes, the bank may be willing to lend you way more money than that (Ahmed-Haq was once offered a mortgage that would have taken 60% of her after-tax monthly income to carry, 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 payments as large and as often as they want. 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.
5. Write off liabilities
Run your own business? If you have built up 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 as a business expense. 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.”
6. Use your tax refund to pay down your debt
With tax season coming up, you may be looking forward to a refund. As tempting as it is to spend all that refund money on something indulgent, like a shopping spree or a vacation, you could consider using some of it to get rid of your debt. True, it’s not as much fun as a vacation, but doing this can ultimately help you put your finances back on track this year. So, if you’re expecting a hefty refund due to an RRSP contribution or a charitable donation, think of the guaranteed rate of return you’ll get by paying down your mortgage. Or paying off your credit cards. With the high interest rates most cards charge, by paying them off sooner, you’ll actually save a lot of money in interest later.