How do I get my debt to disappear?
Let’s keep it real here… we’re in 2020 and debt for many people and families is just a way of life. A middle-class family can’t pay cash for a home outright in North America, so are carrying a mortgage. There may be a car payment as well, with that being your next most expensive financial transaction. These debts are secured against assets however, so we consider them to be “good debts” because you can always sell the asset to pay off the debt. Done deal!
It’s those unsecured loans, lines of credit, and the dreaded credit cards that are considered “bad debts”, for three reasons:
- they are not secured by an asset;
- they are often a high(er) interest rate; and,
- they’ve often accumulated as a result of excessive spending (spending that could be avoided).
Who wants to take 2 years to clear their debt? Not many people, so they end up selecting a debt “disappearing act” that isn’t the best for their overall financial picture, OR they’re not considering all aspects of their choice.
Let’s explore further.
Rolling your debt into your refinanced mortgage
Often looked at as a “cheap” way to clear high-interest consumer debt, using the equity in your home to roll in your consumer debt ACTUALLY ends up costing you more in most cases. Let’s consider:
- you’re only spreading your debt over a longer period of time (the amortization period of your mortgage i.e. 20 years) at a lower interest rate for the near-future. Who knows what the interest rate might be in 15 or 20 years?;
- you’re not clearing your debt, you’re simply moving it to reduce the equity value in your property – your net worth doesn’t change; and,
- most people end up using that newly-available credit room and adding more debt to their personal finances, thereby reducing their overall net worth to the detriment of their financial health.
Debt Consolidation Loan
Another method of immediate gratification, a debt consolidation loan issued by your bank, will freeze your high interest accumulation and provide a strict payment plan. If that’s what serves you and you no longer need that revolving credit vehicle, this may be the best option for you. However, keep in mind that you’re now losing whatever credit cards or lines of credit you’re consolidating. Those accounts will get closed out by the loan provider as part of the consolidation to prevent further increase in debt, and similar to rolling it into a mortgage you’re not clearing that debt off but rather moving it.
More Drastic Measures
Your financial situation may be beyond a simple debt consolidation or refinance, and more drastic measures may be required. If that’s the case, credit counselling is available free of charge in Canada to help you determine the best route for you: consumer proposal or bankruptcy. While both options freeze the debt and negotiate a settlement with your creditors, a bankruptcy has a more drastic liquidation and potential loss of property than a consumer proposal, and a greater negative impact on your credit.
Where do you start with debt reduction?
Before you can truly explore which options are best for you, take a deep dive into your actual numbers and what’s realistic for you to reduce your debt on your own.
- Is there a lower-interest credit vehicle available for you to move some of your debt to (without it being a debt consolidation)? This could reduce your interest.
- Are there non-registered (non-RRSP) investments that you can liquidate to reduce your debt? Odds are your investment isn’t making a return more than your 19% credit card interest payment so it makes financial sense to release those available funds and reapply them to your debt (note, ONLY if they’re not RRSP assets, because RRSP assets are taxed and a percentage withheld when you withdraw them prematurely, which ends up costing you more).
- Making diligent and committed payments, while not reusing any of the freed-up available balance, can effectively reduce your debt over time. Contacting your creditors and requesting an interest rate reduction is an option that can help you make a larger dent in your balance owing with each payment.
Immediate gratification with debt reduction may feel good, but can have greater consequences in the end, so make a fully informed choice and talk to a financial professional to explore all your options.