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Debt Management

Strategies for paying down debt

A report earlier this year by TransUnion revealed the average Canadian’s non-mortgage debt reached $26,221! That’s a hefty chunk of change! If you’re anywhere near or over this number, it’s time to buckle down and save.

When it comes to paying off debt, there are many trains of thought. So how do you attack it, so you don’t derail? Well, we’ll look at a couple of ways.

Paying off your highest interest debt first

Using this method, you list all your debts in order of their annual percentage rates (APR) from highest to lowest. The interest on some high-interest credit cards and pay-day loans will eat up any payments you make at an alarming rate and only end up going towards paying the interest on the loan and not your principle. So if you have a lot of high-interest debt, this is where to start.

But be conscious of the “real” interest rates when writing these down, not introductory rates that your credit card may offer. Also, beware of hidden fees and consider any tax incentives that usually favour things like student loans, especially when the loans you’re comparing have similar balances and interest rates. In Canada, you can claim the interest portion of your student loans on your taxes (up to 15%, as of this writing), plus other educational tax incentives.

Paying low balances first

No not that’s not a typo. It does say low balances. This may come as a surprise to some as to why anyone would even pay your low balances, before your high ones. But it’s one that’s garnering a lot of attention, since Dave Ramsey popularized the ‘snowball method’, in his book The Total Money Makeover, where he suggests you take your smallest debt, pay that off while making only the minimum payments on your other loans. When your first loan is paid off you essentially snowball that monthly or bi-weekly payment into your next smallest debt. The theory behind this is that the small wins you get, give you quick feedback and momentum to attack all your other debts. And you’re more likely to stay motivated. Or at least that’s the point.

But it takes more than a snowball…

Now I understand that debt is a bit of mind over matter. But wouldn’t your mind be more at ease knowing you made a smarter financial decision? Sure, when you’re paying off your little debts first, the first win always feels the greatest. But as you get to the next larger balances, suddenly your little win doesn’t seem all that big.

While a lot of people have had success in this method, and while anything that encourages you to pay off debt is a good thing, I think it becomes a bigger issue when you’re dealing with big debt loads and higher interest rates. Look, if you need the motivation to pay down debt, the one thing you can do is come clean about your debt. Let people know. If you’re not ready to tell your family, share your debt experience with others, be it a close friend or whoever it may be. You need a good support system. Just like some people need their gym buddies to encourage them to go, it can be sometimes hard to get motivated on your own. Especially because most of us are so focused on how much debt we have left, instead of all the progress you’ve made already. Stop flipping to the last page of the book.

Snowballing your payments is no doubt a great way to build that momentum, but when you’re paying off your little debts first, you can end up paying a lot more, for a lot longer. Now that’s not to say that all its principles are bad.

Put those snowballs to better use

You may have heard of the term “debt avalanche”. It combines a few of the two methods mentioned above. Similar to the debt snowball method, except that you list all your debts from highest interest rate to lowest. Now we’re talking! Make the minimum payments to all your other loans and when you’re finished paying off your first debt, you snowball that into the next one.

Luckily there’s some great tools and apps out there to make it a lot simpler. They’re not the prettiest, but here’s a couple of my favourites:

  • The snowball calculator from What’s The Cost. It uses both of the methods I mentioned above to calculate your debt snowball/avalanche, you just need to set whichever snowball method you prefer, interest order or balance order (or see which one will save you the most).
  • Dinkytown’s Enhanced Loan Calculator. Just select Calculate for Term. Fill in your loan amount, interest rate and monthly payment and this will quickly show you how much of a difference an extra $50 or $100 will make. Unfortunately, it takes only one debt at a time.

In any case, whatever tools or methods you decide to use, the important part is that you start! Your debt won’t disappear in a day. It’s a process, but a little patience and a lot of persistence will get you there.

Imagine your world debt-free. Because it’s closer than you think

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