Prioritize Debt Reduction to Unburden Yourself
Average Canadian Individual Debt Increasing
Earlier this year, TransUnion reported that the average Canadians non-mortgage debt increased from $20,785 to $21,348 in Q1 2016. This is an increase of 2.7% from Q1 2015. While personal debt is not necessarily a bad thing – particularly when interest rates are low, it is a bit concerning, especially since according to StatsCan the median total income in 2014 was $32,790.
This means that the average Canadian individual is carrying non-mortgage debt of nearly 2/3rds of their annual income. If this average individual also has mortgage debt, this makes a potentially stressful situation even worse.
Typical non-mortgage debts are debts that are related to education, cars or lines of credit.
Debt is Working Against You and Your Future
When it is all said and done, you have to pay your debts back. However, the longer you take to repay any debt the more long-term damage you are doing to your financial potential. The faster you are able to pay off debt, the faster you can redirect what were previously debt repayments towards investments that will grow over time.
The faster you are able to focus on investing as much as is comfortably possible, the longer you have for these investments to compound before your retirement. Typical interest rates charged against debt are also significantly higher than market returns, so paying debt off is usually the best return on your money you can get. Obviously there are exceptions to this though.
For example, say you have a 0% interest car loan that is amortized over seven years. Due to the 0% interest rate being charged, paying off your loan at a faster rate than the full term would benefit your bank more than it would benefit you. Instead, take the typical interest payment that you are avoiding and diligently invest it instead. That part is key. If you were to just blow the savings on consumer spending, that would be throwing away the compounding potential of that money had it been invested instead.
Being on the Hook for Large Amounts of Debt can be Very Stressful
When I first graduated from university, I was on the hook for a large student debt which I lovingly referred to as my “student load”. Entering the workforce was an extremely stressful time period for me, as job prospects were not terrific where I lived and I felt like this debt was a massive burden that would be really difficult to overcome.
First Step to Repaying Student Debt: Becoming Employed
Given how financially unsavvy I was at the time, there are some decisions I am very happy to have made, while I wish I’d been a lot more frugal or smart in others. The first “smart” thing I did was unintentionally undersell myself in the first job interview that came my way. I felt the interview went well, but I was completely caught off guard when my interviewer asked what starting salary I was looking for.
I said the first number that came to mind. Weeks later, while working at my new job I would realize how much of a deep discount I’d given my new employer. This wasn’t as cringe-worthy as it seems though, as I had succeeded both in being employed in my field of study and securing a steady paycheque. Several peers I graduated with were not as fortunate as I was. Almost ten years later, and some people I know have still never been employed in our original field of study.
Second Step: Repayment Schedule
Once I had my job, I set up a bi-weekly payment schedule that would automatically go towards my loan. Whatever I had leftover was then spent on rent, food, entertainment, etc. I was sharing a house with several roommates at the time, so this kept my rent low. This baseline helped establish a habit of aggressively paying down my debt. This routine brought stability that then allowed me to focus on how to improve my financial standing. Obviously in order for my plan in eliminating my debt to work, I needed to avoid adding new debt. So I resisted the urge to spend additional money wherever possible.
Third Step: After Debt is Paid In Full
A common behaviour for many people upon receiving a raise or inheritance, etc is to immediately increase their standard of living. Any financial gains they received are spent instead of saved. You’ve paid off your debt – congratulations! It’s tempting to celebrate being debt-free by changing your regular payment that had been going towards debt to now increase your standard of living, or maybe you deserve to buy an expensive gift as a reward. However, the best reward for being debt-free is the ability to remain at your current standard of living, but now redirect your bi-weekly payments towards building up investment savings that will instead gain interest for you and not for your bank. Choose well-diversified medium risk funds and indexes over GICs or bonds, and start saving for a secure financial future.
Things I did that Helped and Things I did that Mostly Didn’t
In addition to having low rent, I avoided high cost items like a new car, and the temptation to get a mortgage for a house despite lending rates being very low. I eventually did break down and buy a car, which I regret having done, but the sad reality is that public transit is not exactly world-class in most Canadian cities. Having your own car makes a huge difference in the winter, and also makes day adventures into nature much easier. Given that I love to hike and ski, these would be less accessible to me if I didn’t have my car. Owning my own car has been a massive detractor in my ability to save money though, so despite the fact that it is extremely convenient, I am not certain it is actually all that worth it in the long run. I do try and offset the cost by letting people carpool with me to work, and every little bit helps. I also wish that I had eaten out at restaurants less often, and that I paid more attention to buying routine consumer products when they were on sale instead of at their regular price. These are things that I still struggle with even to this day, but I am aware of it and trying to kill the habit.
When confronted by large debts that seem overwhelming, tackle them head-on by establishing a regular payment schedule that prioritizes payment from your paycheque straight to the debt ahead of all other living expenses. Avoid additional spending and large expenses like cars, homes, etc. Remember that whenever you are able to save money, this is an opportunity to pay down your debt even faster. Stick to the plan, and before you know it, you’ll see that debt steadily decreasing. Once debt-free, redirect what were previously scheduled as debt payments into long-term investments instead.