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The Art of Debt Repayment, a Skill You Can Learn!

04 November 2018 by National Bank

Credit card, line of credit, car loan, student loan… all debts must be repaid, some quicker than others.

Like most people, your income is probably drained on a monthly basis by various debts: car loan, student debt, credit card balances or the payments for that living room furniture you bought six months ago.

Which debt should you pay off first? A seemingly easy question that could have short, medium and long-term effects on your wallet.

Know the Cost of Every Debt

Take for example a car loan. Your financial institution more than likely gave you financing with an interest rate ranging from 6% to 9%, depending on the type of loan. Perhaps you managed to get a better rate if you purchased from the dealership directly.

What about that student loan? Government aid generally offers the best interest rate.

“The government provides a period of up to six months after graduating before you must start the repayment of the student loan,” explains Bajeenthan Baskararasa, Personal and Small Business financial Advisor for the National Bank. “And that interest is tax deductible.”

What’s more, the repayment terms can be staggered over 10 to 15 years depending on the contract signed.

Since the car loan is a more expensive debt (because the interest rates are higher), you can benefit from paying that off more quickly.

By making a list of your debts and the total amount still owed, you will know pretty quickly which one you should prioritize.

Deciding Between “Good” and “Bad” Debt

“Good” debt is that which is considered to be an investment, which will be profitable in the long-term. Student loans or mortgages fall into this category as becoming a home owner allows you to tap into the real estate market.

"Bad" debt is when the loan is used to purchase things that will quickly lose their value or that you will not be able to repay in full (and on time).

This is the case with department store credit cards. “The interest rate is really high and if you don’t manage to pay the minimum balance every month, you will quickly find yourself paying off the interest but not the capital,” warns Mr. Baskararasa.

Same thing goes for in-store financing to buy merchandise. Some offer loans that allow, for example, 18 months without interest.

“This can be useful if you don’t have the funds in hand,” explains the personal financial advisor. “But if you can’t pay the amount owed when it’s due, the interest could increase from 0% to 18%.”

It seems that a debt can go from “good” to “bad” pretty quickly!

Pay Attention to your Credit Score

Your credit history is created once you borrow money or put something on credit. Lenders grant or deny loans or credit based on the credit rating you are assigned by one of the credit reporting agencies in Canada.

Scores range from 300 to 900. The higher the number, the less risk you represent to the lender. Delays in payment are one of the factors that contribute to a lower score.

If you forget to make a payment, it affects your score, which depends on whether you repaid after 30, 60 or 90 days. "Most financial institutions offer to automatically collect the minimum amount each month to avoid a delay, but you have to ask," says Mr. Baskararasa.

“The level of debt is another factor that affects your score. If your credit limit is $10,000 and you use $9,000, then they consider that you rely heavily on credit,” he adds.

The Importance of a Good Credit History

Contrary to what one might think, never having borrowed is not necessarily a good thing. "If five or ten years after graduating, you want to buy a property or a car, lenders will be hesitant to give a loan to someone who has no credit history,” explains Mr. Baskararasa. “And if they agree, it will be with less favorable conditions".

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