When it comes to sensitive subjects, managing debt ranks right up there with firing up a chainsaw or a blowtorch before you’ve read the operating instructions. Like any other power tool, debt can help or hurt you depending on how you use it. So, how do you manage desirable debt, and steer clear of the dangerous kind?

Canadians in Debt

Debt is a serious concern in Canada. In a recent Bloomberg Businessweek piece, Canadians were reported to have the highest debt load relative to our Gross Domestic Product among the world’s major “Group of Seven” economies. In 2018, we had collectively incurred a 174 per cent ratio of debt-to-disposable income, or a total of $2.16 trillion.

That’s a lot of debt. As the Bloomberg column reported, “Household debt in Canada, a nation generally known for moderation, has reached levels that could be qualified as excessive.”

Managing Desirable Debt

Again, there is such a thing as good debt. It generally has two qualities:

  1. The interest rate you’re paying is reasonable, such as a few percentage points in current markets.
  2. It’s for a financially constructive purpose, such as a student loan, debt to finance your business, or a mortgage for your home.

How much debt you have matters as well. If you take on more than you can repay in a reasonable timeframe, what may start out as good debt can quickly go bad.

Avoiding Dangerous Debt

What about bad debt? Bad debt comes buried in the fine print of all those enticing offers you’re always receiving: new credit cards, second mortgages, and (among the worst offenders) lines of credit. These kinds of consumer loans may seem like blank cheques. You may not even think of some of them as debt. But you need to pay attention! The interest rates you’ll pay for that “easy money” can easily leap into the double digits. And the stakes if you default or fall behind on your payments can be horribly steep.

To make matters worse, you can’t count on most lenders to warn you away from bad debt. There’s a reason you receive so many offers. These sorts are making a killing when they sell you their loans. Fall behind, and they may quickly own you for life. As the Financial Consumer Agency of Canada warns us, there are even credit “counsellors” out there, claiming to help you get out of debt, only to trick you into taking on even more – from them.

Three Rules for Dodging Bad Debt

Again, you don’t have to be at zero debt to achieve financial harmony. On the other hand, once you’ve fallen into a deep, dark trap, it’s usually tough and expensive to climb back out. So, here are my three handy rules for achieving balance between what you’re earning and what you’re owing.

Rule #1: Take control of your debt, so it doesn’t control you. If you are going to incur debt, reach out to reputable providers offering low-interest loans with reasonable terms. Apply debt strategically, for constructive needs like education, home ownership, and your business. As much as you may crave new patio furniture or a fancier vacation, going into debt to do it does not pass the “good debt” test. Also, before you sign any more loan documents, try having a conversation with an independent planner who has nothing to sell you.

Rule #2: Have a detailed pay-back plan from the start. Establish a disciplined routine and timeline for paying off debt. If you fall off-track, don’t despair; it can happen to anyone. But do take immediate steps to recover your footing. It’s so much easier to dig back out of a financial hole, if it hasn’t yet gotten too deep. If you’ve got credit cards, as most families do, pay them off in full every month. Yes, every time. With their high interest rates, credit cards need to be thought of as a convenient way to spend money you already have. They’re NOT to be used as a money tree.

Rule #3: Watch out for those sales pitches. Just because a lender tells you that you’re credit-worthy, it doesn’t mean you should be flattered enough to borrow from them! It could be a bank trying to sell you a credit card, a lender pitching you a second mortgage, or an offer to extend your kids’ college loan credit lines.  In general, when a lender is reaching out to you, you can bet it’s because they expect to profit from the exchange.

Digging Out of Debt

What if you’re already in over your head? The hardest part is getting started on a recovery. A professional advisor can help – although, again, watch out for the wolves posing as providers. If somebody is offering you an “easy fix” that sounds too good to be true … Guess what? It probably is

Sometimes these are lessons we learn the very hard way. In the moment, bad debt can grant you something you dearly want, such as new clothes or a luxury automobile. Unfortunately, after the moment has passed, it can ultimately take away your freedom.

What other questions can I answer for you about your money? I’ll be in YOUR debt if you let me know.