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Understanding Debt

Borrowing money can work for you or against you, depending on how you handle it. If you borrow wisely, debt can be a valuable tool that helps you manage expenses over a period of time. But if you use debt carelessly, it can threaten your financial future.

Your Credit Rating

The better your credit rating, the more likely financial institutions will be willing to lend you money and the more likely you will receive a low interest rate. If you have a poor credit rating, you may be charged a high-interest rate or refused a loan.

Before financial institutions extend credit, they assess your credit rating. This is a review of your ability to repay a debt, based on your character, income, economic history (employment, previous financial records, etc.), and assets (savings or other property). Financial institutions often check with credit bureaus for information about your history with other companies, like telephone companies and banks.

You can request a copy of your own credit report and you can have the credit bureau correct any errors in it. The two main credit bureaus in Canada are Equifax Canada Inc. and TransUnion Canada.

Types of Credit

  • Credit cards are convenient for purchases or getting cash for short-term emergencies, but the interest on many cards can become very costly if you don’t pay them off quickly.
  • Loans or lines of credit provide flexibility to pay for large purchases or pay down high-interest loans, provided you can comfortably fit the payments into your monthly budget.
  • Overdrafts help cover debits or cheques when there isn’t enough money in your bank account. It’s convenient, but adds costs to your transactions.
  • High-cost loans like pay cheque advances or some deferred payment plans from retail stores may appear attractive, but they can also be very costly. They can charge very high interest rates and fees.

Before You Borrow

  • While debt can help you achieve short or long-term goals more quickly, your debt payments will reduce the amount of money available for investing or other financial goals.
  • Understand the loan contract before signing it. If you aren’t sure what something means, ask for an explanation.
  • Make the payments as agreed. If you run into trouble, don’t avoid it. Talk to the loan/credit officer and explain the situation.
  • Interest on debt adds to the overall cost, so be sure you understand what interest you’re paying and factor any additional fees or interest into your monthly debt payments.
  • Debt can be expensive, so your best financial strategy is usually to pay it off as quickly as possible.

 Avoid Dangerous Debt

  • Keep your credit rating positive. Pay your bills on time, and don’t take on debt you can’t pay off.
  • Go to reputable agencies like banks and credit unions for loans.
  • Keep some savings ready for emergencies.
  • If you run into credit problems, you can get free or low-cost advice from community and government organizations. In BC, you can get information from the Credit Counselling Society.
  • Be on the watch for scams and rip-offs. Check the Fraud Awareness section of InvestRight for information and warnings about investment scams, and the Better Business Bureau for consumer scams in your area.