Managing Debt Wisely: Minimizing High-Interest Debt
Debt can be a useful tool for achieving life goals like owning a home, pursuing education, or starting a business. However, it can also become a heavy burden, sometimes causing financial instability, stress, or making it more difficult to achieve long-term goals.
This four-part blog series will cover four major components of wise debt management, each of which plays a crucial role in building a secure financial foundation:
- budgeting and creating a repayment plan
- minimizing high-interest debt
- building an emergency fund
- seeking professional advice
High-interest debt is a huge obstacle to debt repayment. Avoiding, minimizing or re-financing these debts can significantly reduce your repayment costs and simplify your finances.
Prioritizing Paying High-Interest Debts
High-interest debt, such as credit card balances and payday loans, can make it hard to chip away at the balance owing, or even cause the debt level to escalate, due to compounding interest. You should avoid payday loans completely, and try not to accumulate a balance on credit cards. Here’s why:
- Payday loans are high-risk because they come with extremely high interest rates and fees, often equivalent to an annual interest rate of 300% or more. This makes it easy for borrowers to fall into a cycle of debt, as they may struggle to repay the loan and be forced to take out new payday loans to cover the previous ones, quickly escalating their financial burden.
- Credit Cards: The average credit card interest rate ranges from 15% to 25%. It is best to only use credit cards for amounts you can pay off in full at the end of each month, to avoid carrying a balance and incurring these interest fees. If you do have a balance, paying more than the minimum amount due each month is essential to keep your balances from accumulating or stagnating.
Other types of loans or credit often come with lower interest rates than payday loans or credit cards, but it’s important that you are aware of the interest rates they carry and the potential for rates to change depending on how you use them or how long the balance is kept. Evaluate the interest rates and repayment schedules on all loans to help identify the most efficient payment plan.
By paying down high-interest debt first (the Debt Avalanche method mentioned in Part 1 of this series), you reduce the overall cost of your debt and free up funds that can be allocated to lower-interest balances or savings.
Debt Re-Financing Options
Debt refinancing, or consolidation, is a way to simplify if you have multiple debts, and it can reduce the interest rate on your debt if you can obtain a loan at a lower interest rate to pay out your existing high-interest debts. Some ways to refinance include:
- Many credit cards offer promotional 0% interest rates on balance transfers for an introductory period. By transferring your high-interest balances to one of these cards, you can focus on paying down the principal without additional interest charges, provided you pay off the balance before the promotional period ends.
- Taking out a personal loan to consolidate high-interest debts can offer a fixed interest rate, simplifying monthly payments. This option can be especially beneficial if you have a good credit score, as it can lead to a lower interest rate.
- Homeowners may consider using home equity to consolidate debt. These loans typically have lower interest rates, although they use your home as collateral, increasing the risk if you default.
If you’re insolvent, you may have other options for refinancing that offer greater relief but come with negative consequences for your credit rating, such as the Orderly Payment of Debts program, or a Consumer Proposal. These can be extremely helpful if your debt level is unsustainable, but careful consideration with the help of a professional is needed.
Before you enter into any debt refinancing plan, it’s essential to review all terms and conditions carefully and to consider your overall financial situation. Taking on new debt has a tendency to worsen your situation overall if you haven’t fixed the underlying issues that caused you to accumulate the debt in the first place. For this reason, it’s essential to first prepare a comprehensive budget to ensure you will be able to pay off the debt.
Charla Smith & Company is a Calgary-based Licensed Insolvency Trustee, serving the southern Alberta region. We regularly help individuals navigate their options for dealing with their debt. If you'd like a free, no-commitment consultation to review your options, contact us.
Disclaimer: This publication provides general information and should be seen as broad guidance only. The information contained herein cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon this information without obtaining specific professional advice relating to your particular circumstances. Charla Smith & Company Ltd. does not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.
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Frequently Asked Questions
Sometimes, the best way to improve your score is to truly fix the underlying issues causing you to overuse or default on credit. A Licensed Insolvency Trustee (LIT) can review options for resolving those issues so that you can stop the cycle of debt. AnLIT can also provide referrals to trusted individuals who can help where we can't. Book a free consultation to find out more.
There are many people who sell advice and/or help with credit ratings, or give advice online, but proceed with caution. Some are more knowledgeable and reputable than others, so you'll need to do your research. There is no magic pill to increase your credit rating, so be cautious about paying anyone who says there is. If you’d like to get in touch with an expert who deals specifically with issues on credit reports, you can contact Richard Moxley at The Credit Game or take a look at the resources he has made available on his website.
Other options include finding a way to afford your debt payments like budgeting and cutting expenses, negotiating a lower interest rate informally or through a debt management plan, the Orderly Payment of Debts program, or debt consolidation. Alternatively, you may need the comprehensive relief from debt provided by Bankruptcy. See Everything You Need to Know About Debt Settlement for an in depth discussion.
Be careful where you get your information about your options. Inaccurate and biased information is abundant, particularly on the web. A good, reliable resource to check out is the Government of Canada’s website. Licensed Insolvency Trustees are also a reliable resource, as they are specifically educated in this area and are licensed and regulated by the government.
The cost of a debt consolidation loan is not just about the monthly payment. You will pay interest on your debt, and you may also be charged fees upfront or while you are paying it off. The total cost of your debt consolidation loan is the overall amount you will pay by the time it is finished.
If you are offered a specified payment timeline with specified monthly payments, you can simply multiply your monthly payment by the number of months included in the timeline (and add any upfront fees you have to pay).
However, in some cases, you will have only a minimum monthly payment and you can decide how much to pay each month (such as in the case of a line of credit or a credit card you’ve used to pay your other balances). And often in these cases, your interest rate can fluctuate, either due to fluctuations in the prime rate or because an introductory interest rate expires. In this case, it is much harder to estimate how much it will cost you, and the amount you will pay overall depends on how much you choose to pay each month. If this is your situation unless you have some good spreadsheet skills you may need some help, such as contacting a Licensed Insolvency Trustee, to figure it out.
For illustrative purposes, I'll provide a few examples of the costs of a consolidation loan which show that the cost can vary substantially with different consolidation loans. These examples will be based on the assumption your consolidation loan amount is $25,000 and you can afford to pay up to $600/month.
Consolidation loan with $500 in up-front fees and an interest rate of 25% and a payment timeline of 10 years.
- Your monthly payment would be approx. $580
- By the end of the 10 years, you would have paid close to $70,000, including the initial fee and nearly $44,000 in interest
Line of credit with no upfront fees and an interest rate based on the prime rate which happens to be 5% at the time you take it out (a very good deal - you must have a very good credit rating and a good relationship with the bank). Let’s assume the prime rate goes up by 0.25% each year, and therefore so does your interest rate.
- Your minimum monthly payment would start out at approximately $104, which pays only the interest.
- You choose to pay $600 per month, so it will take you almost 4 years to pay it off and you will have paid nearly $28,000, which means you will have paid nearly $3,000 in interest on top of the original loan
- Note: If you only ever pay the minimum monthly fee (ie. the interest), you will never pay the debt off. Over the course of 20 years you will pay more than $30,000, and you will still owe the original $25,000
Credit card with an introductory 0% interest rate. It charges a 3% fee for balance transfers, and the interest rate increases to 20% after 12 months. There is also a $50 annual fee.
- The 3% balance transfer fee will amount to $750.
- If you pay $600/month starting right away, you will pay it off within nearly 5 years and you will have paid nearly $34,000, including the transfer fee, annual fees and nearly $8,000 in interest. Note: If you pay only $100/month for the first 12 months, then increase it to $600 when the introductory period is over, it will take you nearly 7 years to pay it off and you will have paid approx $43,000, including the transfer fee, annual fees, and over $17,000 in interest.
If you are struggling with debt, there are several signs you might be heading for the sweatbox or, worse, already there. If you’re not sure, check out our blog 5 Signs You’re Already in the Financial Sweatbox or contact us to discuss our debt.
Absolutely. A Licensed Insolvency Trustee can talk to you about an array of options, including a Consumer Proposal. There may be some options that are not realistic for you, based on your situation. A Licensed Insolvency Trustee will meet with you and go over the options, helping you figure out which options are realistic for you and which one is the best to deal with your debt. Contact us to book a meeting to find out more.
- Typically, LITs focus on either consumer solutions or corporate solutions.
- Consumer solutions include Consumer Proposals and bankruptcy.
- Corporate solutions include Division I Proposals, bankruptcy, receivership, and plans under the CCAA (Companies Creditors Arrangement Act).
Charla Smith has experience delivering all of these options, so if you would like information on any of them, please contact us to find out more.
YOUR TRUSTED CHOICE FOR DEBT RELIEF
With our experience and our caring approach, we will help you find the best option for debt relief based on your unique situation - from advice on talking to your creditors to a consumer proposal or bankruptcy, and everything in between. We are here to lift the burden caused by overwhelming debt.
Contact us today at 1-403-899-3890 for a FREE, no-commitment meeting, and let us guide you to regaining your financial footing.
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