Tackling debt

Now that you have decided to get your finances under control, the biggest challenge is to pay off your debt. The biggest question probably is “where do I start?”. A lot of people are in complete denial when it comes to their debt level, until they reach a breaking point. Before you actually make any payment plan, you first need to know how much you owe, and to whom.

Go through your files and list every single debt you have. Include your mortgage, car loan, credit cards, lines of credits, student loans, personal loans, loans from family and friends, loans from work etc…etc. Also write the interest rate for each. Add everything up. Now, you have a clear picture.

Second, you need to have a budget in place. Not all your money can go towards debt repayment. You also need to save for your emergency fund. It may sound counter-productive to do this when you have massive amounts of debt, but you have to. Life happens. Set-backs happen. Accidents happen. If you don’t have any savings, how are you going to face an emergency? Yep, by creating more debt!

Now you have these systems in place, focus on your consumer debt, family and student loans. Leave out your mortgage and car payments, as these are in separate categories in your budget. A rule of thumbs is to allocate 15% of your net income towards debt repayment. To reach this percentage, you will probably need to cut down on other categories such as entertainment, vacation and restaurants. You may also need to increase your income to cover for all the items in your budget.

There are a few options to tackle your debt. You can seek a consolidation loan. This type of loan combines all your debts into a single monthly payment. It allows you to pay off your debt more efficiently and you will save on interests. The current interest rate for an unsecured consolidation loan in Canada is 5% to 6%. It also makes budgeting and saving easier. It is what I did for my own debt…so far, so good.

If you don’t qualify for a consolidation loan, you can start making payments on the highest interest-bearing debt you have and only make minimum payments on your other debts. Once you have paid it off, move on to the next high-interest one.

Or you can start with the smaller balance. A lot of people find this method keeps them motivated as they can see progress faster. You will pay more interests though.

The key to success for these methods is to close the accounts you paid off…and no open any new ones. Aim to pay off your debt within 3 to 5 years. Beyond that length of time, you will pay way too much interest and will most likely suffer from debt fatigue.

Should you use a credit counselling service?

Image result for credit counselling

Let’s start by defining what “credit counselling” is. It is a process that involves offering education to consumers about how to avoid incurring debt and helping debt repayment by establishing an effective debt management plan and budget.

Written like this, it might sound interesting and appealing, particularly if you are in a difficult financial situation. Unfortunately, the majority of credit counselling agencies do not have your best interest at heart, including the ones claiming to be “not-for-profit”.

The main goal of these services is to set you up on their “in-house debt repayment plan”….and cashing-in on your dollars. With a debt repayment plan, the service will contact your creditors on your behalf, and either offer a lump-sum payment on your debt, or arrange for a monthly payment for a number of years.

This is never done for free, including at so-called not-for-profit societies. Did you know these organizations receive the majority of their funding from banks, credit card companies and other financial institutions? And where do you think this money is coming from? Yep, you got it…. from you!

Some agencies can receive up to 50 cents on every dollar they collect on behalf of your creditors. On top of this, they will charge you a monthly administration fee, to cover for their overhead costs. People working there are not volunteers, they are employees.

Back in 2008, when my own financial situation was getting desperate, I went to see one of these agencies. Of course, the “debt repayment plan” was the only way to go, even if it was not adapted to my problem at the time. The proposed monthly payment was too high compared to my then income. It also included a $40 administration fee I disagreed with.

I never signed-up for it, despite several follow-up calls from the company. I am glad I didn’t, as it would have trashed my credit score and put me in a worse situation, financially speaking. Credit bureaus treat debt repayment plans the same way as a consumer proposal or a bankruptcy. It will stay on your file for at least 6 years.

If I had done this, I would have probably never been able to buy my condo. I don’t think highly of this kind of services. Credit counselling agencies are nothing more than collection agencies, minus the harassing part.

If your financial situation is getting to this point, you are better off meeting with a Trustee in Bankruptcy to review your options. Because you are going to see a Trustee doesn’t mean you have to file for bankruptcy. Bankruptcy is definitely not the only way  to get out of debt