Debt

An important subject to understand and control

Debt, a form of owing someone else something, (usually money) has always been with us in some form or another. It is an ever-increasing part of all Western societies. In the first quarter of 2017, for example, Canadian total mortgage debt reached $1.341 trillion, compared to consumer credit debt of $595.3 billion. (Source: CBC, June 2017).

The ratio of debt to disposable income edged down to 166.9 percent [...] in the fourth quarter [of 2016]. That meant Canadians owed C$1.67 for every dollar of disposable income. (Source: Reuters, May 2017)

These numbers are often too large to comprehend. However, what people do understand and studies have supported is that having debt has a number of negative effects on our families and our lives.

So why are we getting in debt more and more? BECAUSE.......

WE LOVE TO SPEND, sometimes we are under control and other times we are not. We give in to pressure, advertising, fashion, trends and big companies… although satisfying in some degree, it can end badly. 

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What Debt is and Why it's Growing

In order to understand why debt goes up so much for so many of us, we need to understand that our debt means profit for our lenders. This is probably not news to most of us, but let's dig a little deeper here and understand how financial institutions benefit from our debt and how they market financial products to increase their profits.

What am I buying and how much will it cost?

On a basic level, we're buying a service that gives us immediate financial freedom to buy consumer goods (credit cards), finance projects like new cars or home reno (i.e. bank loans) or home ownership (mortgages). However, it's a bit more complex to really assess the price we're paying for these services. 

Of course, we have to pay back the initial sum we received from the bank. On top of that, however, we will also have to pay interest for that loaned sum.

Fair enough, you might argue, since, theoretically, you could have put that sum on an account and get interest for that period of time. Yes, and no! Here's the kicker: the interest you get from the bank for money you save on their accounts is far lower than the interest somebody would have to pay them for getting that same money as a loan.

Banks make profit by investing someone's money and paying little interest to them but loaning the same money out to you and demanding a higher rate of interest from you. This ultimately leads to you getting poorer, although you might have satisfied certain wishes and wants in your life. In the long term, the increased debt payments will keep you from achieving financial freedom and independence.

Psychological Draw to Spend Beyond your Means (Marketing)

Financial institutions have a vested interest in growing this lucrative business. Therefore, they use all their marketing might to convince society 

that it's far more preferable to satisfy every need immediately, and

that loans are attractive and cheap ways to make that happen.

Since they have common interests with businesses that want to sell their products and services, they collaborate on sending out this message. This is the reason why we all see and hear it everywhere, and why we've come to believe that this is simply the way the world works.

Make the Effort to Withstand the Temptation

To actually question those wishes and wants that have been put into your head by commercials, society & peer pressure is the only way to take back financial independence and peace of mind. It's also probably a very unattractive way of living for the first little bit, because it contradicts everything we're told daily. Fair enough, building up funds might be hard work. However, once having some funds build-up, it is very rewarding to know that you have enough for both emergencies and little luxuries in life, and that you're not held back by payments you have to make for money you borrowed for things you might have lost interest in long ago.

Bad and Extra Debt

Your families expenses will continue going up if it keeps spending on things that aren't affordable. That is Bad Debt. It is then exasperated by having to pay more interest and possibly penalties because minimum payments aren't being made. That is Extra Debt (or more Bad Debt).

How to Reduce Debt

There are two main ways to reduce debt. The first is to go to the company you owe and renegotiate your situation. Either write down the principal owed or the interest on the principal (even better would be to get both written down). The second way is to reduce expenses and put the savings towards the debt. Applying both methods together will reduce the debt quicker.

What if you have multiple debts? Which one to pay off first. The decision about which one you pay off first is tricky. The key is to start paying off some unless you recognize the most critical in terms of amount owed, time, and interest rates.

Typical Types of Debt

Educational tuition

It is getting more and more expensive to pay for further education. The average graduate is usually in debt around $30,000 after graduating. Yikes, that is a poor start to the rest of your life. That makes it much more important to learn how to look for scholarships, grants and bursaries and attend a school that costs a reasonable amount.

Credit Cards (instant easy money)

To some, it seems like free money or at least they spend it like it is free money. It is not free! In fact, it can be very expensive. With loans being a few interest points above prime it is much wiser to get a loan or even better a line of credit than to have credit card debt with around 20% interest.

Do you have Credit Card Debt that is hard to pay off? Your first idea should be to try and get a lower interest rate loan or line of credit. A line of credit is nice to have because it is always available whereas a loan must be paid off then applied for again and again. A lower rate of interest could save thousands in payments. More of your payment can go towards the principal. Look for websites that help look for a lending company to match your needs. One such site is Fiona. It is easy to use and will help find you a lower interest loan.

Loans

Yes, it is nice to be able to get loans at historically low prices. But it is also necessary to remember that a loan of $5,000 at 5% over 5 years still costs around $650 in interest. That kind of money could be used much more wisely. Simply planning and saving ahead could reduce that amount in half or more. Loans must be paid back according to a scheduled contract.

It may be wiser, if possible, to get a line of credit. Once you have it then you don't have to apply again or until the contract runs out. Lines of Credit usually remain in place for a long time and in fact may be renewed by the financial institution indefinitely. The interest rates don't vary either as are set in place at the time the LOC is created, they remain the same for the duration of the contract. When you want a loan, the LOC funds are there for you. Similar to a credit card but usually at a much lower rate unless you get a special credit card with an introductory rate. Lines of Credit may be secured or unsecured. You can apply for a Line of Credit at any banking institution. 

Mortgages 

This is the most expensive debt you can get into. It is also the most complex debt you can get into. There are several ways that the amounts to be paid can catch you off guard. They won't be crippling usually but the may be more costly than expected.

One thing to know isn't about debt. It is about the fact that mortgage payments are created in such a manner that the bank makes almost all of the funds at the beginning of the mortgage. Mortgage payments pay down mostly interest early on plus of course the banks want as much interest as possible. The more they make the more you pay. That means that you are paying out rather than saving the funds yourself. This is funds that you could be using to pay off debt or paying off the principal on the mortgage. Learning about mortgages is critical to good budgeting. Learn how to pay mortgages down quicker by reading the internet, talking to friends in the know, and asking your bank how to save more and pay less interest.

The costs of owning and maintaining a property can cause a lot of stress on the family budget and also cause other payments to be deferred and therefore in debt. Paying for properties means to find out all of the upfront costs needed and all of the backend costs needed.

• Besides the mortgage, there could be tax adjustment/payments to be made. If you're purchasing a property you will need to pay a portion of the taxes that the owner has already paid
• there will be legal fees for the lawyers unless you can swing a deal with the bank because you're a special case
• transfer taxes
• mortgage insurance (this could be quite a large fee)
• possible renovations or repairs needed or wanted 
• condo fees or maintenance house costs including building and garden tools

These costs can place a lot of stress on the family budget so beware of them and plan for them before buying a property. You don't want to have to wind up getting extra loans to cover all of these possible costs.

Some people simply don't realize how much a property can cost until they get stuck with extra costs. Make sure you learn a bit about all of the payments that are needed to own a property. Question your bank mortgage officer on how to pay less interest. Check out the internet on how to pay less interest. Talk to friends about paying less interest. It helps you, the mortgagee in the long run. Don't just listen to and take the offer the bank gives you. It's in your best interest to be more learned and careful about mortgages, after all, it can mean paying 20-25 years or paying the mortgage off a few years earlier and becoming mortgage-free.