Credit cards and loans have carved a foothold in North America and many find themselves swimming in debt.
CGA Canada released a report in late 2008 indicating that Canadian households had $1.3 trillion of consumer debt that was incurred for mainly consumer purchases. More alarming was the fact that 58% of those with rising debt stated day-to-day living expenses was the reason for the new debt.
If used wisely debt can be a valuable tool and if used for investment, the interest may offset your investment income. If debt is not used wisely, it can strain your budget or force you into bankruptcy.
Four Key Strategies For Debt Management
The debt management and elimination strategy you use should take into account your long and short term goals, tax situation, and to a certain extent the amount of risk you are prepared to assume.
1. Tackle High Rate Interest First: This is a strategy where you attempt to pay off those debts (typically credit cards) with the highest interest first and then move to the next highest. And so on.
2. Tackle Non-Deductible Debt: A 7% interest rate on your car loan will cost you la lot more than a 7% interest rate on an investment loan. If you are in the top marginal bracket, the after-tax rate on the investment loan will only be 3.85%. Stated differently, the same person needs to earn $1.82 to pay $1.00 of the car loan debt.
Strategies such as the Smith Manoeuvre or Singleton Shuffle that exchange non-deductible debt for deductible debt can be used to reduce your after-tax interest expense. Be careful with this strategy and make sure it is done right to avoid and negative consequences.
3. Consolidate Debt: If you have too many individual payments to make, you might consider a consolidation loan. This strategy consolidates all of your debts into one single payment and a lower overall interest rate. For this strategy to really work, you must ensure you do not allow yourself to go further into debt!
4. Tackle The Mortgage: I wrote about this topic earlier this year in 5 Tips To Pay Off Your Mortgage. Essentially, the size and length of time of your mortgage combined with the magic of compound interest results in a truly staggering amount of interest over the term of the mortgage.
Other Options
Other options to reduce or eliminate debt include the consumer proposal or bankruptcy. These strategies can impact your credit rating and severely limit your ability to borrow funds in the future.
