Dealing with Crushing Debt
By Arnold Machel, CFP®
“Put God in charge of your work, then what you’ve planned will take place.”
Proverbs 16:3 (MSG)
Last month we talked about good debt vs. bad debt. Of course, it’s best if we only go into good debt and only by a reasonable amount, and with a payment schedule that we can handle. But the reality is that sometimes thing go wrong. What do we do then?
Maybe you’ve got yourself in trouble. It feels like you are at the end of your rope. Whether good debt or bad debt, when the debt starts crushing you, it’s high time to take action. It can be tempting to consider bankruptcy or debt settlement arrangements, but they will adversely affect your credit rating for a long time and typically only make sense if you have little or no assets. While you may wish to explore this avenue just to know what your options are, understand that it is not an easy out.
In most cases, it’s possible to dig oneself out of significant debt, even when it feels crushing. All we need is a lot of hard work and a plan. We can do this! Take a breath and relax. Grab a pen and a paper or sit down with a spreadsheet open in front of you and start by understanding the debt that you’ve accumulated.
Make the following columns…
- Institute (who you owe the money to)
- Type (is it a mortgage or a line of credit or credit card debt or…)
- Amount Owed (in dollars)
- Maximum Credit Limit (use only if it’s a revolving credit facility like a line of credit or credit card)
- Rate (the interest rate – be sure to use a standardized rate – 5% compounded monthly equals the same as 5.12% compounded annually)
- Is it tax deductible? (Usually yes, if borrowed for the purpose of investing to earn income or a student loan; otherwise no)
- Minimum monthly payment
- Comments (Is there collateral? Are balloon payments coming up? Does the interest rate jump up in the near future? Are you currently making excess payments? Is this a debt to family that you just wish to place a high priority on? etc.)
Now start filling them in. Complete a line for each and every debt you have, no matter how small or to whom you owe it.
Before dealing with the debt, it’s quite possible that you will have to address a spending issue. There is no benefit in reducing debt, only to go right back into it. For this exercise I’m going to assume that spending is now under control.
The classic mistake I see is not concentrating on one debt at a time. That makes it hard to see progress. Typically, the best strategy is to hammer down on one debt at a time. Make minimum payments on all the others while focussing on just one loan – usually the highest interest one, simply because it is the one that is costing you the most.
So we want to rank the loans in the order that we plan to focus on them. As noted above, that will generally be in the order of the highest interest rate first, but before going there let’s review each debt and look at it from a bigger picture. Some things to consider…
- Is some of the debt tax deductible? If so, adjust or note the effective interest rate to take that into account (if you’re not sure, talk to a professional).
- Are there a lot of loans or just a few? If there are many and one of them could be paid off quickly, the feel-good boost of getting one down might out-weigh the extra savings of the high interest one.
- Do any have exceedingly high minimum payments? Similar to above, the added flexibility of paying that off quickly may out-weigh the extra savings of paying off a higher interest debt.
- Is it possible to use a lower interest rate facility to pay off a higher interest rate facility? Sometimes this can result in huge savings. Just be mindful of the minimum payments on the new facility. Be careful not to jeopardize your ability to make the monthly payments.
- Are any of the terms flexible? Can you reduce the payments on lower interest debt so that you can increase them on higher interest debt?
- Might any of the lenders be willing to adjust the terms without affecting your credit rating? For example, the Canada Revenue Agency often will forgive fines. Smaller lenders may also be willing to re-negotiate the interest owed.
With all of that in mind, you can now make a plan.
First, restructure the debts as much as possible to get your interest costs as low as possible and your payments as flexible as possible.
Then decide which debt to focus on first. Pour every spare penny into it. Allocate the majority of any bonuses, tax returns, raises, etc. to get it paid off. Have a little (inexpensive) celebration when you’ve finally paid that first one off. Reward yourself in some small way – you deserve it.
With that first one out of the way, now you will be able to use the extra cash-flow to hammer down on the next debt. And so on, and so on.
It may not feel like you are getting very far very fast at first. And it will probably take a few years, but with a plan of action, you will get there. And with a plan of action that focuses on paying the high interest debt first, you will get there sooner.
Arnold Machel, CFP® lives, works and worships in the White Rock/South Surrey area. He attends Gracepoint Community Church where he serves on the Leadership Team. He is a Certified Financial Planner with IPC Investment Corporation and Visionvest Financial Planning & Services. Questions and comments can be directed to him at dr.rrsp@visionvest.ca or through his website at www.visionvest.ca. Please note that all comments are of a general nature and should not be relied upon as individual advice. While every attempt is made to ensure accuracy, facts and figures are not guaranteed.