In our current environment, we are seeing personal debt levels at the highest they have ever been being met with increasing borrowing rates. It was bound to happen. Pair that with insane real estate values and the highest inflation rates we have seen in 40 years. But take a breath, the sky is not falling. Our current conditions have been buffeted by the very significant impact the pandemic has had on our economy. But, as with most things, it will find a balance. This is not unique, we have been there before and came out of it ahead.
When we speak with clients, one of the most sensitive topics of conversation is personal debt. The word debt can often have a bad connotation, but not all debt is necessarily bad.
Some types of debt, such as student loans and mortgages, allow you to use leverage to help you better your financial future. Plus, their low interest rates enable you to take advantage of cheap financing over time.
On the other end of the spectrum is what we refer to as bad debt. Unlike low interest rate debt, bad debt is a loan that’s issued with a significantly high interest rate, usually a rate north of 20%. In other words, bad debt is debt that has little chance of being paid back with interest. This is a characteristic that can be particularly toxic to both the lender and the borrower.
The loan will usually cost you significantly more than the value of the loan amount. Examples include payday loans, or loans from predatory lenders that are characterized by unreasonable fees, rates and payments.
When you’re strapped for cash, payday loans seem like an easy fix as they can be a quick way to get the money you need, but their interest rates are exorbitantly high. In some provinces without regulations, you might pay more than 500% in interest for just a short-term loan of a few hundred dollars, which quickly grows over time when you can’t repay the balance.
Because bad debt could be wreaking havoc on your finances without you even realizing, below we share signs you might already have it, plus tips to avoid or get out of toxic debt.
Signs of bad debt
Are you making consistent payments towards a debt obligation, yet the balance continues to still grow because of a high interest rate? This is one sign your debt is bad, leaving you stuck paying off a forever accruing balance and never actually getting rid of the debt entirely.
A second sign is if your debt-to-income ratio is high. This ratio shows how much debt you have relative to your income. Whereas a low debt-to-income ratio indicates that you earn more than you owe, a high ratio means that more of your pay goes toward paying your debts.
To calculate your debt-to-income ratio, divide your total monthly payments by your gross monthly earnings before taxes and any other deductions. This calculation will naturally take into account the interest rate you pay on your different debts each month, so you can see how it all adds up quickly. The higher the ratio, the higher your debt obligation is, and you’ll want to take immediate steps to pay down your debt.
Tackling bad debt
It’s obvious that you should try to avoid toxic debt at all times, but that can be easier said than done.
If you find yourself in a situation where you have an immediate need for additional cash, consider first asking a family member or trusted friend to borrow money and creating a repayment plan with them.
Another option is to take out a personal loan through a bank or credit union. Personal loans often have lower interest rates than credit cards, and consumers can use them to finance nearly every kind of expense or to consolidate debt.
If the above options aren’t viable, you could lastly consider using your credit card, whether by simply swiping it or taking out a cash advance. Cash advances usually have a fee of about 5% or more. You’ll start getting charged interest immediately on the cash advance. Though credit cards have some of the highest interest rates, it’s still less expensive than what you would pay if you take out a payday loan you can’t afford to pay off.
In this scenario, it is important to also talk to your credit card company about lowering your interest rate. You could also consider taking out a low interest rate credit card or a credit card with a interest free introductory period. Cardholders usually must complete balance transfers within 60 days from account opening. This is one of the longest interest free periods for both balance transfers and purchases. With such a long introductory period, ideally you can pay off your debt within that time frame and not have to pay additional interest.
With all of these options, it’s important to create a plan to repay this debt. We recommend reviewing your budget to see where you can reduce spending and start building an emergency savings fund so you can avoid this in the future.
The bottomline
And if you already have bad debt, prioritize taking steps to eliminate it completely.
Start by talking to a credit counsellor or who can help you explore your options. The most reputable credit counselling ng organizations are nonprofits, and you can take advantage of their programs free of charge or at an affordable fixed rate. You won’t pay high fees to meet with one. To get started, search for an accredited credit counselling organization in your area.
You can also take more personal control over your finances. Sometimes you do not know where to start. Meeting with a financial advisor can allow you to integrate all your goals and objectives into a financial life plan. This is where we start. We create a base line from which to build your plan. One of the key considerations is your personal debt. We will ensure you categorize your debt into good debt and create strategies to eliminate any bad debt. Taking charge of your life and your finances can seem daunting but critical in Keeping Life Current.
