Recently, the media has repeatedly mentioned that Canadians are in too much debt. However, I feel that it is important to clarify which kind of debt you have. I would like to propose 3 categories: bad, necessary and good.
Usually bad debts are things or expenses that you do not need to have right away. Incurring debt to buy things you don’t have to have is bad. A new pair of shoes, ski equipment or a vacation can fall into this category.
Necessary debt are things you have to have, but unfortunately do not have money to pay for it at the time. For example, you need dental work done due to a cavity. You really can’t wait, and you definitely need this. Paying this by credit and making a few interest payments might be your only option.
Good debts are debt that you incur that can improve your financial situation. Borrowing to buy a house, to get a good education, to set up investments or to start a business are all examples of good debt. Most successful businesses borrow money at some point in time.
Take a look at which categories your debt resides and make a commitment to reduce your bad debts. Wait until you save enough money. But even then assess whether you can put that money to better use elsewhere. Make a list of things you need and the things you want. Make sure you spend your money on the needs first.
Regardless of what types of debt you currently have or how you categorize them, you should always try to replace your high interest rate debt with low interest rate debt. A common practice is to get a second mortgage (borrowing using your house as collateral when you haven’t paid off your original loan yet) loan to consolidate a number of credit card and unsecured line of credit debts. Depending on your financial situation, a second mortgage can start as low as 4%. More typically we are looking at 9 to 10%. The effect is usually more cash flow and pay less overall interest. Currently the standard VISA or MasterCard charges 19.9% interest. Department store cards are often at 29.9%.
Often we do not plan to get in debt because if we did we would set up a secure line of credit and/or a low rate VISA card. The rates are about 4% and 10% respectively. You may end up saving a lot if you have this set up ahead of times. Worth considering.
