This post was originally published back in June 2016. 18 months later, it is still one of our most popular subjects, how the hell do I get out of consumer debt? With Christmas behind us, the credit card bills will start to roll in and many tears may be shed. We thought this post can help you get through this season without going into a full-blown panic attack. Some of these tips are for future use, while others can be used right now.
Some of the questions you may be asking yourself is: how do I pay off debt? What is debt? Why can’t I ever get ahead? We all have access to many forms of debt; credit cards, line of credits, etc. What debt is good? What debt is bad? In keeping with our theme of making personal finance simple, for today’s post, we are going to dissect consumer debt.
Consumer debt is the most common type of debt and where people get into the most financial trouble. This is any money we owe due to a purchase of goods or services and does not appreciate in value. Using your VISA to buy a new outfit, a dinner out or movie tickets is considered consumer debt. For many people, getting access to credit (how often do you get mail from xyz credit card company/bank saying you’ve been pre-approved for a new credit card?) is very easy. However, where we get in trouble is not knowing our credit card balance. Off the top of your head, do you know your credit card balance? Add another two to three credit cards and it’s easy to get overwhelmed when those bills show up. To top it all off, it is typically the most expensive type of debt. Most credit cards charge you around 20% interest on money you borrow!
Make sure this type of debt is under control before focusing on anything else.
No point in putting money into your RRSP or doing renovations when you have a ton of consumer debt hanging over your head. Paying this off is easier said than done, so here are some helpful hints about managing it:
Never use cash advance on credit cards
DO NOT DO THIS. SERIOUSLY, DO NOT DO THIS! The second you take cash out you are being charged interest around 20%. Cash advances from a credit card rank as the most expensive thing you can do. You will be charged interest right away. If you have no other resort but to do this because you are in a crunch, pay it off the next day to avoid a super shitty bill.
Only have two credit cards MAX!
You want to limit your sources of consumer debt. Our trick is to have one credit card with a very low limit that we use every day and pay off regularly (Anywhere from $1000-3000) and the other one with a higher limit (say $10,000) that would be used for very big purchases (items for your home, a vacation, etc). Only use the second one if you know you can pay it off quickly.
Prioritize your debt payments
Always pay off the debt with the highest interest rate. If your credit card is 20% and your line of credit is 6%, pay the minimum on the line of credit and put all your funds towards paying off that credit card. It will save you a lot of extra dollars in the long run. List all of your consumer debts into one column. Beside it, list the interest rate for the debt and then write down the amount you owe. Organize these by interest rates (highest to lowest) so you can see which debts to pay first.
Consolidate your consumer debt
If you have a lot of consumer debt (the amount which keeps you up at night), our advice is to go to a bank and get a Debt Consolidation Loan or a Personal Line of Credit. Move all those high interest debts into a low interest loan and cancel all the cards you don’t need anymore. Remember, try to get down to only two credit cards.
For example, a few years ago, Lindsey got a line of credit from TD Bank at 6% interest and moved the balance from her 3 credit cards (which were all 19.9% interest) onto that line of credit. Then she cancelled two credit cards and reduced the limit on the third one until she got herself out of her debt. If your bank won’t do this for you, reach out to a debt consolidation firm that could help you with this.
Use savings to pay off debt faster
As noted in an earlier post, it is almost always better to pay off debts before saving/investing your money. Use these savings to pay off your high interest consumer debts. Don’t worry about “good debts” (mortgage) and focus on the “bad” consumer debts (credit cards). If you put $1000 into your RRSP with 5% return you’ll only be making a potential of $50 in earnings. Whereas, you put that $1000 onto a credit card that has 19.99% interest rate, you’ll be saving $200 in interest charges – you’re up by $150!
Always pay off your credit card balances
If possible, pay off your entire credit card balance (or as much as possible). Even if you have to use a line of credit to do so, that is a better option. It makes sense to pay the lower interest rate (i.e 6%) with a line of credit then the full 20% from the credit card. The caveat to this is that you can’t simply rack up the credit card again once it is fully paid off; you have to manage the line of credit till the credit cards are paid down.
We know post-holidays can be a financially difficult time for a lot of families. We hope these tips can help you organize your consumer debts and start you on the path of reaching your financial goals. If you need additional help, reach out to us and pick our brains for some tips and advice. We would love to help!