Nancy Graham February 10, 2021 Personal Wealth Good Debt, Bad Debt, and Uncertain Times It’s probably safe to say, few of us imagined what we’d be facing in 2020 before the year arrived. Even if you had wisely established a rainy-day fund for just these sorts of uncertain times, it’s possible you underestimated how long or severe uncertainty can be. If so, even as a stalwart saver, you may have taken on some debt to see you through – or you may at least be considering it. As we’ve covered before, I like to compare debt to a power tool – like a chain saw or blowtorch. It can help or hurt you, depending on how you use it. In good times and bad, how do you manage acceptable debt, while steering clear of the dangerous kind that only makes things worse? Canadians in Debt Even before the pandemic, personal debt loads were a concern in Canada. In a March 2019 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. By the end of the second quarter 2020, Global News reported our household debt ratio had increased to 177 per cent, or a total of $2.33 trillion. Yes, 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 … or at least better and worse kinds of debt to incur in extraordinary times. “Good” debt generally has two qualities: The interest rate you’re paying is reasonable 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 an acceptable 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 we’re always receiving: new credit cards, second mortgages, and (among the most tempting offenders) lines of credit. These kinds of consumer loans may seem like blank cheques. You may not even think of them as debt. But the interest rates you’ll pay for that “easy money” can easily leap into the double digits. Also, the penalties can be horrible if you default or fall behind on your payments. To make matters worse, you can’t count on most lenders to warn you away from bad debt. For example, even as I was working on this piece, I called my bank to change a password … and was asked if I’d like to increase my credit limits. No thanks! Bottom line, when you borrow, they make money. And if you fall behind, they may quickly own you for life. You’ll also want to be cautious about credit “counsellors”. They may claim to be there to help you, but they may be making money in ways you don’t see, which can muddy their true motivations. 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 trough, it’s usually tough and expensive to climb back out. So, here are 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, essential needs like education, home ownership, and your business. As much as you may crave new patio furniture or that hot gaming console for your kids, going into debt over it does not pass the “good debt” test. Also, before you sign any loan documents, try having a conversation with an independent planner, or a reliable, financially savvy friend who has nothing to sell you. Odds are, they’ll offer better advice than a lender looking to profit from your debt load. 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 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 month. With their sky-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 says you’re credit-worthy, it doesn’t mean you should be flattered enough to take their offer. It could be a bank trying to sell you a credit card or increased credit line (like mine just tried to do); a lender pitching you a second mortgage; or an offer to extend your kids’ college loan lines of credit (for which you’ve probably co-signed). 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 the ability to continue spending beyond your current means. But unfortunately, after the moment has passed, it can ultimately take away your freedom, for good. What other questions can I answer for you about your money? I’ll be in YOUR debt if you let me know. Share: Facebook Twitter LinkedIn Email IIROC AdvisorReport