5 Ways to Get Out of Debt in Canada
5 mins read
Being in debt and trying to get out of it can be overwhelming at first, but achievable if done the right way. Read more to learn the different techniques of how to get out of debt in Canada.
The process of getting out of debt isn’t easy. Sometimes you’re stuck in a situation where it’s hard to keep up with all your bills, which causes you to make only the minimum payments on your debts. You risk getting trapped in debt for years if you only pay the minimum payments of your debts. First, understand you are not alone in this situation. In 2021, about 70% of Canadians had debt, with an average per-person debt of around $23000 excluding mortgages.
Fortunately, several methods exist of getting out of debt and healthy habits to avoid getting into debt. This guide will outline these different methods and habits, giving you the confidence to start your journey and be debt-free.
What is my Total Owing ?
The first step to getting out of debt is knowing exactly how much you owe and to whom. This might sound easy, but many people do not have an exact amount for their debt. Work out what you owe, know the different balances, the different interest rates of each debt and to whom these debts are owed. This will get you to know exactly what you’re in for and enable you to build the best action plan around that. Get to know your total monthly revenue and total monthly expenses. Yes, you’re right! I’m talking about budgeting. The results of this exercise may be discouraging because you might find out you don’t have a lot of room in your budget but keep in mind the end goal and that getting out of debt is not an overnight process but a journey.
What’s the Best way to Pay Off Debt?
The best way of paying off debt can be different for everyone. It depends on each person’s disposable income, interest rates on their debts, the amounts owed, financial goals and even personal goals. Here are the five methods of getting out of debt:
1. The Avalanche Method
This method focuses on paying the debt with the highest interest rate first. First, you should rank your debts from the highest interest rate to the lowest. Next, while still paying the minimum payments on your other debts, you should devote any leftover funds to the debt with the highest interest rate. Once that debt is paid off, you move to the debt with the second highest interest rate and so on. It is a highly efficient way of paying your debts because it reduces the amount of interest you accrue, stopping your debt with high-interest rates from costing you more over time.
Let’s say you have a $16000 credit card debt with 19.9% APR, an $8000 car loan with 6% APR and a $3000 personal loan with 8% APR. You’ll pay as much as possible on the credit card debt every month until it is completely paid off, while paying the minimum payment on the car and personal loan. Next, you’ll move to the personal loan and so on.
Advantages: It is cost and time effective. This method helps in paying less accrued interest over time and therefore enables one to get out of debt faster.
Disadvantages: It works when you have a steady income and somewhat of an emergency fund. If you are thrown away by an emergency like a car repair, the efficiency of this strategy can be undermined.
2. The Snowball Method
This method takes a similar approach as the avalanche, but here, you should rank your debts by their amounts from the largest to the smallest and pay off the smallest amount first as much as you can with your disposable income. Of course, while still paying the minimum payments on all your other debts to avoid having late payments. When the smallest debt amount is paid off, you move to the second smallest and so on.
Let’s say you have a credit card debt of $8000, a student loan of $12000 and a car loan of $4000. With this method, you’ll make your minimum payments on the credit card and the student loan, and pay as much as possible on the car loan until it is paid off. You’ll then move to the credit card and pay as much as you can and so on.
Advantages: This method keeps you motivated as you can see your progress quickly when successfully paying off the first small debt.
3. Debt Refinancing
The avalanche and snowball methods are great for paying off debt. However, as you noticed, they rely on having disposable income to pay down debt faster. This might not be possible for everyone’s financial situation. Fortunately, this method answers that problem.
This method uses a completely different approach, which consists of refinancing your debts to lower interest rates. This can help in better managing debt repayments.
One way of doing this is through a debt consolidation loan. Here, you will take a loan with a reasonable interest rate and use the funds from the loan to pay down all or most of your creditors. This enables you to have one debt to deal with and one minimum payment.
The second way of refinancing is a balance transfer credit card. Here, you can transfer the balance of your credit card debt to a credit card with a lower interest rate or sometimes no interest rates for some time.
Advantages: This enables you to focus on one or fewer debts with a more manageable minimum payment. Also, the interest rate can be lower, making you save money in the long run.
Disadvantages: Debt consolidation loans require an ok credit score for approval or sometimes collateral. Also, creditors might request the closure of the credit accounts after the debt pay down, which might negatively affect your credit score. This method takes more time to repay debt.
4. Commit Windfalls to Debt
Getting out of debt can be a long process. Therefore, any chance you have to make this process faster should be seized. When you receive a tax return, bonus check, cash gift or any non-recurrent amount of money, you should immediately pay down your debt balance or use a good portion of it to pay down your debt.
5. Debt Relief Solutions
These are last-resort solutions which should be considered only if after a debt consolidation loan, you are still unable to repay your debts. These solutions are consumer proposal and bankruptcy. A consumer proposal enables you to consolidate all your debts, stop future interest charges and repay only a portion of the total debt you can afford. The remaining balance of the debt gets forgiven. On the other hand, bankruptcy is a legal solution that could enable you to get all your debts forgiven. There are criteria you have to fall in to be eligible for one of these solutions, and only a licensed insolvency trustee can offer you this type of solution. If ever in need, you have to contact them to discuss your situation.
Disadvantages: It negatively impacts your credit file for a long period of time, generally seven years.
Who is it for: Anyone who cannot pay back their debts in their current situation.
Good Habits For Success in Getting Out of Debt
Avoid taking more debts
The first step in getting out of debt is to stop taking on new ones. Identify the root cause of all these debts and cut them off. Getting out of debt faster requires either spending less or earning more money. It may not always be possible to make more; therefore, spending less is more feasible. Look at your budget frequently and classify them by necessities. Make the necessary adjustments and cut off any unnecessary spending which can bring you back into debt. Use any extra cash to pay back your existing debt while always using your credit card wisely.
Have an emergency fund
It is possible to both contribute to your savings and repay your debt at the same time. Having an emergency fund is recommended because it is what will prevent you from getting back into debt if ever an unplanned event arises, such as a car repair or even a job loss. It is advised to have at least three months of essential expenses as an emergency fund.
Be consistent in your payments
The most effective way to make your debt repayments is by having them automatically withdrawn from your account. Stick to the plan you set in the beginning and only modify if improving your repayment plan, meaning increasing the payment amount.
Know where to get help
If you’re trying to pay down debt and need help with any of the above steps, seek professional help before experiencing challenges. You can contact a financial advisor at your current financial institution, usually free of charge, or you can contact a licensed insolvency trustee for help with a consumer proposal or bankruptcy.
Improve Your Credit Score
Unpaid debts have a massive impact on your credit score and can lead to increasing your interest rates. A good move for getting out of debt is to improve your credit score, which helps lower your interest rates. If you are a tenant, Kredax will soon offer the opportunity to improve your credit score with your rent payments. Join the waitlist and be notified when this opportunity is available.
Bottom Line
Getting out of the debt cycle is not an easy task. That being said, as you now know, it is possible and requires planning and consistency in applying the appropriate strategy. Understand what initially got you into debt and modify those behaviours to avoid getting back into debt in the future. Start today and improve your future financial health.
