Inflation is driving up the cost of food. Rising gas prices make getting to work more costly if you are not working from home. And pandemic ‘shortages’ mean the cost of almost everything is on the rise. While there may be some relief in terms of house prices appearing on the horizon, for renters, landlords continue to pass along rising costs to tenants with higher rental rates.
The end result is that it’s even harder today to make ends meet. For many Canadians living paycheque to paycheque means more credit card debt, not less. And too many households are a week or two away from resorting to payday loans and high-cost installment loans.
So how do you control your debt when your budget is stretched? Read on for some personal finance tips that can help you deal with debt when you can barely manage to keep up with living costs.
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Avoid going deeper into debt
One of the most common concerns I hear when talking with people on our helpline is “I’m not even living paycheque to paycheque, I’m going deeper in debt every pay period.” If this sounds like you, you are not alone. This is the most common path to bankruptcy for most of my clients.
While I know it’s hard, if you are struggling to balance your expenses with your income, my number one piece of advice is to put away your credit cards and live on cash (or cash equivalent like your debit card).
This is especially true if you owe money on your credit cards. Most credit card companies charge interest daily if you carry a monthly balance. In other words, if you don’t pay your balance in full each month you lose the grace period for new purchases. So if you have credit card debt, stop using your cards until they are paid off.
Using credit to pay bills is a temporary money fix. Eventually, your credit cards will be maxed out and you will be tempted to turn to high-cost payday lenders. This creates a cycle of debt that is hard to stop.
Be prepared for unexpected expenses
Living paycheque to paycheque is even more stressful when you lack financial control to deal with unexpected expenses that arise.
The first financial goal I recommend to most of my clients is to set aside a small emergency fund of $500 to $1,000 in a separate bank account. This is not money you turn to when you run short at the end of the month. Try not to use this money to pay for everyday costs like groceries and gas. It’s money meant for surprise costs like a car repair, medical bill or visit to the vet. The objective is to have a small amount set aside so you don’t turn to your credit cards or other debt to pay for emergencies.
Pay your bills as you get paid (it’s easier than budgeting)
I’m not a fan of formal budgeting because I know it’s not sustainable for most people. What I generally recommend to anyone starting fresh with money management is to pay your bills as frequently as you get paid.
The general idea is to pay a portion of your next month’s bills and set aside enough money for future bills, every payday before you spend any other money. What is left after doing this is money you can spend on extras, put towards debt payments or savings. You are using your paycheque cycle as a budgeting tool.
There are many benefits to this approach to budgeting:
- you don’t need to keep track of anything or use any spreadsheets
- it prioritizes necessary bill payments over wants helping you avoid overspending
- you won’t have any late payments which can harm your credit score.
So here’s how this works.
If your cell phone bill, for example, is $120 a month and you are paid weekly, every week set up a bill payment for $30 to your cell phone provider. This way, if the bill comes in you don’t need to scramble to find $120 in an empty chequing account.
For bills, you can’t pay periodically, like your rent, you can use separate holding accounts to accomplish the same thing. Let’s say your rent is $1,800 a month and you are paid weekly. Simply set up an automatic payment to transfer $450 each week into your ‘rent account’. When your rent is due, use this money to pay your landlord.
The key here is to know what bills you have coming in over the next 30 days, and what money you might need to set aside for future bills like your car insurance, Christmas gifts etc. You carve money out of each and every pay to cover these costs.
Any money left over the day after allocating to your bills is yours to spend as you wish. As long as you don’t spend more than this using credit cards, you have a balanced budget and stop living paycheque to paycheque.
Protect yourself from income loss
Losing a job, or income loss is the most common cause of the primary causes of insolvency in Canada.
As many people found during the pandemic, no job is secure. That means you should always be prepared for the possibility that your income will drop. As the saying goes, hope for the best but plan for the worst. Here are some tips to help you be prepared:
- Keep an up-to-date resume (and on your home computer not your work computer).
- Update your skills to improve your employability, both with your current employer and for a possible future employer.
- Know where you might find your next job. You don’t have to be thinking about quitting your job but it’s always a good idea to know what else is out there in case your company lets you go unexpectedly. This can also help you negotiate for more money come raise time.
- Network with people in your industry or with people who work in an area you might want to move to.
- Take pride in what you do. It doesn’t matter what your skill set is, an employer is most likely to retain or hire someone with a positive attitude, and who is willing to learn and improve.
Other things you can do to ensure you have a steady, or better monthly income include getting a side gig to earn extra money if this makes sense for your lifestyle. I’m not suggesting everyone get a second job or another part-time job. I’m talking about looking at ways to use what skills or hobbies you have to create a side hustle that can help you generate a little extra cash.
And don’t be afraid to reinvent yourself. If there is not a lot of job security or room for growth in your current job, take a chance on yourself. Go back to school, build a new skill set, or start your own business.
If you want to learn more about my thoughts on employment, you can hear more on our Podcast Debt Free in 30.
Change your money habits
I’m not here to tell you where to spend your money but there is value in reviewing your spending habits if you are constantly running short of cash before payday.
Look over where you are spending money and ask yourself is this a need or a want. If it’s a want, that’s fine, but weigh that want against putting that same amount of money towards your debt. It’s your choice, your priorities, just make sure you are making a conscious choice each time.
Second, look at how you pay for items. If you are using debt to buy non-necessities, this should definitely stop. As I mentioned before, if your debt is increasing, you may be better off leaving your credit cards at home and paying by debit instead to control the bleeding.
Paying down debt
OK, so what about the debt you already have. I hear from families who were financially devastated by the lockdowns and business closures during the pandemic. Many were forced to take on debt because they couldn’t work. Now they are back at work and it’s time to pay it all back, yet their income isn’t necessarily high enough to pay the bills and pay down that debt.
How do you deal with current outstanding balances when money is tight?
Pay more than the minimum payment
One of the most important facts to learn about credit card debt is that the monthly minimum payment is designed to keep you in debt. It’s enough to cover the interest charges for the month and typically only 1% – 2% of what you actually owe. So if you only pay off 1% of what you owe each month – guess what – it will take 100 months to pay off your balance. And that’s assuming your spending habits don’t cause you to use your card for more purchases each month.
As I mentioned above, if you carry a balance and put new charges on your credit card be aware that you are paying interest on those purchases from the date of purchase.
So begin by paying more than the minimum where you can.
This can be easier if you make a small micropayment towards debt every time you get paid. There is no rule that says you can only make one payment on revolving credit like credit cards or lines of credit every month. You may even be able to pay your car loan in small micro installments if the payments have not been automated already.
Use the debt avalanche method
There are two common approaches to debt reduction: the debt snowball method and the debt avalanche method.
The debt snowball method is where you pay off balances in order from the smallest to the largest. The main, and in my opinion only benefit, of this method is the psychological motivation you get in knocking some debts off your list.
A debt avalanche is a system of debt repayment where you break down your monthly debts by total owed and their interest rates. The loan with the highest interest rate becomes the priority for repayment.
Begin by making a list of all your debts including student loans, payday loans, credit card debt, bank loans, installment loans and any other personal financing. Every debt must be paid on time, with at least the minimum payment. Money that is not budgeted for necessities (or left over each pay when you use my ‘pay your bills as you go’ method) is used to pay down debt.
Imagine you have three loans and $250 available after expenses:
- $500 owed on a credit card with a 20% annual interest rate
- $625 due for monthly car payments at a 6% interest rate
- $2500 on a line of credit with an 8% interest rate
The monthly car payment would need to be met, and budgeted for, as this amount is the minimum. Imagine, the minimum payments on the credit card and line of credit were $50 each. Out of your $250 available, $50 would be put towards the line of credit and $200 on the credit card, since it holds the highest interest rate.
If you didn’t add any new debt to the credit card, you could pay it off in full in two and a half months. The full $250 would then go towards the line of credit. After the line of credit is paid, any extra income can be added to the car loan to pay it off faster or put towards savings or other financial goals.
Benefits of dealing with a high-interest debt first
One of the main advantages of the debt avalanche system is it reduces the amount of interest you’ll pay while paying down debt. And focusing on clearing the most expensive debt will lessen the time it takes you to get out of debt.
I know that debt is emotional and stressful, and most Canadians don’t fully realize how interest rates add to their overall burden. Paying off your debt with the highest interest will give you more financial control and eventually increase the amount of disposable income you have for other things.
Savings vs. paying off debt
As I said earlier, I believe an important priority when financial planning is to have a small emergency fund. After that, your goal should be to reduce revolving high-cost consumer credit.
Once your credit cards and other high-interest debt is paid off, the most common question I get is should I pay down my mortgage or car loan or should I start saving money.
The truth is it’s up to you and should be based on your income stability and future financial goals.
If your employment is at risk you might want to build a larger rainy day fund in a separate savings account to cover maybe three months of necessary expenses. These monthly expenses include rent or mortgage payments, groceries, basic utilities, and car loan payments.
But it’s just as reasonable to start setting aside money for a down-payment to buy a house, to put money in an RRSP or TFSA as long as your high-interest debt is paid off. It all depends on your financial priorities.
Other options for high-interest debt
If the monthly payments for your debts are far beyond your means to pay every month, there are other options to get out of debt. Using a debt calculator can help you explore the options that are right for you.
There is no shame in seeking help to get your finances under control. Speaking with a qualified Licensed Insolvency Trustee will provide you with options for debt relief but here is a brief summary of potential debt solutions that can help you become debt free.
Debt consolidation loan
A debt consolidation loan is a way to combine multiple monthly debt payments in one and potentially lower the interest rate you are charged on your total loan balances.
To be approved for debt consolidation loans, you’ll need to meet these requirements:
- a sufficient and reliable source of monthly income to support the payments
- a good credit score
- collateral or a co-signer is sometimes required
The advantages of consolidating debt into a single new loan are easier to manage payments, a potentially lower interest rate than on your current debts, and you will have a known end date when all your debts get paid off at the same time.
The major disadvantage of this system is the total amount of your debt stays the same. All outstanding loans are simply transferred under one umbrella, and if you have poor credit, the interest rate on this singular loan will likely be high. Also, if you opt for a long amortization to lower your monthly payment, you will be in debt for longer and pay more total interest over time.
A consumer proposal is a popular option for dealing with large and problem debt. Consumer proposals include non-secured debt, such as credit card debt, lines of credit, payday loans, and some student loans. By working with a Licensed Insolvency Trustee, you can negotiate up to a 70% debt reduction. This is an alternative to filing personal bankruptcy and will stop creditors from contacting you.
Repayment amounts are determined based on what is realistic for you to pay and what the debtor expects to receive. Settlements are often drastically less than previous minimum payments, carry zero interest and you will be free from debt within five years.
If personal debt has reached the point where you have no hope of repaying, and you cannot afford a consumer proposal, your next alternative is to consider bankruptcy.
Personal bankruptcy is legally binding and clears your debts to give you a fresh start. There are stipulations and requirements that must be met, including making required monthly payments, reporting your income and attending two counselling sessions, but calls from creditors will stop and your debts will be wiped clean when your bankruptcy is complete. If this is your first time filing bankruptcy, and your income is below the government threshold limit, you can be eligible for an automatic and full discharge in as little as nine months.
Professional financial help is available
Perhaps, the debt avalanche system sounds like a way for you to pay off high-interest-rate loans and save for emergencies on your own. Or, maybe it’s time to learn more about loan consolidation. If debt payments are a reason you are living paycheque to paycheque, reach out for professional financial advice.
The Licensed Insolvency Trustees at Hoyes Michalos are here to help you. We’ll ask some questions about your finances and unique situation and help you decide which debt solution will work for you. If you don’t need to file a bankruptcy or proposal, we’ll tell you that too and provide some insight into how to go about other options.
Call us today at 1-866-747-0660 or book online for a no-obligation chat.