Canadians are in debt. According to a recent report from Equifax Canada, the average Canadian holds $20,759 in debt, excluding mortgages. Most of us didn’t get into debt all at once, either. Sure, big-ticket emergencies can drive a person into debt, but often it’s the little expenditures that do it—the “we deserve it” date nights or that new set of tires on your credit card. These purchases are the culprit of a slow increase in liability over time. The debt seemed to just snowball, slowly but surely. The good news is that the same model that got you into debt can be used to get you out.
It Starts With the Math
Credit card companies make their money off interest and fees, and there are laws that set the maximum legal interest rates that a company can charge. These usury laws vary and can go as high as 45 percent interest. Let’s take a $100 debt as our example. At 10 percent interest, you are paying $8.79 per month to pay off the debt in one year. Most credit card companies have a minimum payment amount, but we will ignore this for our example. If you pay it off in a year, your actual interest paid is 5.5 percent. That is not bad. Now let’s look at a 45 percent interest. At the end of the year, you will have paid $26 in interest at an overall rate of 26 percent.
The Snowball Effect
Using Dave Ramsey’s snowball model, you pay the minimum amount toward each of your credit cards. This keeps all of your cards current and your credit score intact. For the credit card with the highest interest rate, you will pay the minimum plus some additional amount depending on your budget. The more you can pay, the faster the highest rate card will be paid off. When this card is paid off, move to the card with the next highest rate. Continue this process until all the cards are paid off.
There are a couple of quick fixes and warnings that go with paying off your debt. If you have room on your low interest cards, then transfer the debt from high interest to low interest credit cards. This will lower your overall interest paid. Also do not close paid accounts. Credit scores are calculated on the amount of unused credit you have available so a big, empty credit card is great for your score.
Back to the Math
Some of us have large debts in one hand and interest-bearing annuities in the other. If your debt is at 45 percent and your annuity is paying 6 percent, then it would make sense to use a company like J.G Wentworth to convert the annuity into cash, which you could then use to pay down the high interest debt. Using our example from above, a 45 percent debt means that you are paying $26 but your 6 percent investment is only giving you $3. Logic dictates that you would sell the low earner to pay off the high creator of debt.
If It All Gets to Be Too Much
If you can’t seem to get a handle on your debt, don’t be afraid to reach out. Services like Credit Counselling Canada may be able to help. Relief is out there.