Debt can either help or hurt your financial future, depending on how you use it.
If you borrow money 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.
Making Smart Debt Choices
Making wise decisions when borrowing money can help you build on your current or future financial goals. Taking on too much debt or borrowing money just because it’s available to you may not be the best decision. Poor debt habits can put a strain on your financial health and can hold you back from reaching your goals.
Making smart debt choices means understanding when it makes sense to borrow. Borrowing can help you acquire something useful – like a house or an education – that could add to your net worth. It can also help you acquire items like a car that you can’t easily save up for in a timely way.
Poor debt habits and a lack of understanding in what it means to borrow can lead you to financial trouble. Examples of poor debt habits include overspending (beyond your budget) using high-interest credit cards, making late payments, and not having a plan in place to pay off debt.
Before You Borrow
When looking to borrow, it’s important to understand that 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.
Consider the following tips before making the decision to borrow:
- Borrow only when you need to and only as much as you need to.
- Shop around for the lowest interest rate.
- Understand the loan contract before signing it.
- Be sure you understand what interest you’re going to pay and factor any additional fees or interest into your monthly debt payments.
Remember, debt can be expensive over time, so your best financial strategy is usually to pay it off as quickly as possible. The faster you pay off the principal, the less interest you’ll pay. If you miss a payment, your interest rate could go up and you could damage your credit rating. Making smart financial decisions will help build your credit rating, which will help you in the long run.
Maintaining 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.
Tips to Manage Debt
Debt can be a useful financial tool. It can help you buy a car or home. If you use credit cards, there can be added benefits like travel points or extended warranties. But, if you have too much debt, it can limit your financial options, make it difficult to save money, and lower your overall financial health.
Consider these four tips to help manage debt.
1. Identify Your Debts
Start with identifying what you owe, and create a list of all your debts. For each debt, list the total amount you owe, the minimum monthly payment, and the interest rate. Debts can include mortgages, car loans, credit card balances, lines of credit balances, taxes you owe, and more.
2. Review Your Budget
A budget is a plan that helps you manage your money. It will help you figure out how much money you get, spend, and save; balance your income with your regular expenses; and guide your spending to help you reach your financial goals. Use this Budget Planner to find out where your money is going.
3. Create a Strategy
Once you’ve created a list of all your current debts, begin your plan. The types of debt and the amount of debt you owe will affect your strategy for paying them off. Choose a timeframe to pay off debt that is reasonable, yet affordable. If your timeframe is too long, you may lose focus due to a lack of progress. You’ll also end up paying more money in interest. If your timeframe is too short, you may not be able to keep up with your payments. You may start to feel it’s unrealistic to continue. Decide which debts to pay off first. Depending on the type of debts you owe, it may be best to pay off certain debts first, such as debts with high interest rates or debts with the lowest balance.
4. Know Where to Turn for Help
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.
Keep in mind that any money you’re putting toward monthly debt repayments isn’t going toward your savings. The sooner you pay off your debts, the sooner you can put your money into an investment or savings vehicle that will earn you interest.
Avoid Dangerous Debt
Dangerous debt means borrowing too much without a realistic plan to pay it back and losing track of how much you owe. Consider the following tips to avoid dangerous debt:
- Create and stick to a budget, so you don’t have to borrow money to get by.
- Pay bills on time.
- Don’t take on debt you can’t pay off like high-interest credit card debt.
- Avoid borrowing to pay your monthly bills.
- Avoid borrowing to cover luxury expenses, like expensive vacations or pricey dinners.
- Avoid borrowing when you can’t afford the payments, especially if you’re borrowing from high-interest credit cards.
- Go to reputable agencies like banks and credit unions for loans to consolidate your debt.
- Build up savings for emergencies, and to reward yourself for being smart with your money.
- Don’t fall for get-rich-quick schemes or offers to help you get rid your of your debt without understanding the details.