1. Make a budget
“The first step to regaining control of your finances and paying off your debt is making a solid budget,” readily admits Vanessa Houghton, senior advisor at National Bank.
Why? Because if you enter your monthly income and expenses into a budget worksheet, it will be easier for you to see how much money you can use to pay off your debt. “By creating a budget, you may discover other expenses that you can also cut down on,” Houghton adds.
Sometimes, all it takes is grabbing your worksheet and entering your $20 pizza deliveries every Friday night to realize that it’s eating up $80 or more per month and more than $1,000 per year.
Other tools may help you get a better idea of your overall financial situation. For example, National Bank’s account aggregator allows you to get a “360 view” of your accounts via My Online Bank – even accounts at other banks in Canada and the United States.
The mobile app also organizes your expenses and purchases into categories. That way, you can quickly see what takes up a bigger chunk of your budget and eliminate those if necessary.
2. List all your debts
To pay off your debt, you first need to be aware of everything you owe. Make a list of all your debts and include the amount as well as the interest rate you’re paying on each.
Different interest rates mean that two debts that seem similar may not actually be the same. Clearly, a $1,000 debt is bigger than a $500 debt. But owing $500 on your credit card and $500 on a student loan isn’t the same thing. They don’t have the same interest rate.
3. Prioritize certain debt payments
Indeed, paying off certain debts should be prioritized over other debts. How do you choose which to focus on? It’s simple. “Debts with higher interest rates should be paid off first. Usually, these are what cost you the most.”
At the bottom of your list should be debt with very low interest rates, like student loans, which you nevertheless shouldn’t neglect. “When it comes to student loans, the interest turns into tax credit, the rates are low, and you have a six-month grace period after you’ve graduated before you have to start paying it off. It’s still debt, but if you have other debts to pay off too, concentrate on those. And make sure to take care of your responsibilities and your monthly minimum payments for your other debts.”
That being said, despite longer timelines, don’t forget to make a repayment plan for your student loans.
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4. Separate your “good” debt from your “bad” debt
That’s right: there is good debt and bad debt. Good debts are those that are considered an investment, meaning it will be profitable in the long term. “Good debt includes your student loans, which could help you land a good job and a better salary. Mortgage loans are also considered to be good debt. On top of making you a homeowner, your home will also appreciate in value over time.”
Debts are bad whenever the loan is used to purchase goods that will quickly lose their value or that you won’t be able to pay off in full and on time. This is the case with store credit cards. The interest rates are very high and if you’re unable to repay the minimum every month, you may find yourself in a position of paying off only the interest without being able to repay the principal.
Loans taken out to purchase a new car are also considered to be bad debt. Cars depreciate in value quickly.
Monthly payments for a car rental can also turn into bad debt. “Did you decide to go with a fancier model for $50 more per month than what you wanted to pay? If your financial situation has changed in the last few months, this extra $50 per month could compromise your financial stability over time.”
The same goes for in-store financing, like for furniture, for example. “If the seller is offering you 18 months of no payment and no interest, even if it may seem like an attractive offer, this can quickly turn into bad debt. No one can predict their financial situation 18 months into the future. How can you be sure that you’ll be able to pay?”
5. Consolidate your debts
Consolidating your debts means grouping them together and asking the bank for a loan so you can pay them all off in one shot; then, you’ll only have that loan to pay off every month. For example, if you have $10,000 spread out over two credit cards, you could ask your bank for a loan of that amount in order to get the balance of both your cards to zero.
While the bank may establish certain rules to help make sure you don’t end up in the same debt situation again, please note that consolidating your debts doesn’t have a negative impact on your credit score.
You’ll benefit from an interest rate that’s often lower than a credit card’s, and you’ll only have one payment to make every month to pay off the loan.
By saving on interest, your monthly payments may also be lower. And who knows; you may also be able to pay off your debts faster.
“Consolidating your debts is often seen as a last resort. That’s not true. You should meet with your advisor as soon as you have debt, as soon as possible. They will be able to help you find the best strategy, like debt consolidation, to help you regain control of your financial situation.”
Of course, each case is unique. As with any other loan, the bank will analyze your file before issuing you a loan for debt consolidation and establishing the parameters of the agreement.
6. Maintain a good credit score
If you have a good credit score, try to maintain that. If it’s not so good, paying off your debt will help to improve it. Credit scores range from 300 to 900. The higher the number, the less you’re perceived as a risk to lenders. Late payments are one of the factors that reduce your score. The amount of debt you have also determines your score. If your credit limit is $10,000 and you use $9,000, your dependence on credit is considered to be high.
Contrary to what some may believe, never taking out any loans isn’t necessarily a good thing. If you’re buying a home or a car, lenders are less keen on granting you a loan if you don’t have a credit history. That’s why you have to build a good credit report.
7. Pay off your debt, but don’t forget about your emergency fund and your retirement
Even though paying off your debt is beneficial for regaining control over your finances, don’t downplay the importance of building an emergency fund and investing for your retirement. “In an ideal world, you would do all three: pay off your debt, build an emergency fund – which amounts to three to six months of expenses – and invest for your retirement. But since that isn’t always possible, prioritize paying off your debt. Then, you’ll have more money that you can set aside for your emergency fund, and after that you’ll be able to start investing.”
Regardless of your situation, the important thing is to speak with an advisor. “Sometimes, people are embarrassed about their debt and they’re afraid of being judged by their advisor. There’s no reason to be embarrassed, and advisors aren’t there to judge you. They’re there to help you improve your financial situation.”