You are working your full-time job and have a steady stream of income. However, you struggle with saving money and find yourself spending all of what you are making on paying back debt that you have incurred over the years. This is a very common problem amongst Canadians, and many individuals struggle with making ends meet because of huge debt burdens. According to credit agency TransUnion, in 2018 the average non-mortgage debt amongst Canadians was roughly $29,000 per person. A 2018 MNP survey showed that 44% of Canadians are $200 dollars or less per month away from insolvency. Whether it is due to spending habits, unfortunate and unplanned financial circumstances, or simply the cost of getting an education, actively setting a strategy to pay off debt fast is vital to starting the path of saving money for retirement and achieving financial independence. There is very little hope in ensuring a stable financial future and retirement if you are constantly bogged down by debt and interest payments. Paying off debt strategically and quickly isn’t always easy, but it can be prioritized depending on the type of debt obligation.
Here are the four categories of debt to consider paying off in order, starting off with…
1) Personal debt
Personal debt includes credit card debt, and short-term interest-bearing loans that are due within one year. These bear the largest interest rate and are the biggest burden in terms of cost of capital. No one should be paying 19% interest on a bag of Cheezies and a snickers bar that they purchased on a credit card.
Credit card companies are happy with customers paying the minimum payment listed on their credit card statements. Credit card companies are mandated to show how long it would take for someone to pay off their bill if they just made the minimum payments on it. This is supposed to “deter” people from only making the minimum payments and to pay the bills off sooner. The inability to pay off credit card amounts in full simply means that you are spending more than you earn, and this is not a sustainable habit. Does it really make sense to be paying a $500 credit card bill for over 20 months because you only paid the minimum payment? At 19.99% interest, for the time it takes to pay off a $500 credit bill, you will have paid $1,050 in interest alone, and this is on top of the $500! Wow I wish I could get those kinds of returns on my investments.
2) Student debt
According to the National Graduate Survey in 2015, roughly half of post secondary graduates have outstanding student debt upon graduation. 45% of university post secondary graduates, and 20% of college graduates, owed more than $25,000 upon graduation. While student debt is lower for Canadian college graduates simply because of the lower tuition costs compared to universities, the average student debt from universities across Canada is close to $30,000 at the time of graduation.
In Canada, provincial and federal student loans bear different interest rates. Tuition loans have the option of having fixed or floating interest rate payments, and vary across provinces. For simplicity, the Alberta fixed rates are between 3 and 4% right now (this may have recently changed with the new government in 2019), while the federal student loans fixed rate is typically between 6 and 7% (graduate students tend to have high rates compared to undergraduate students). That’s quite high considering that the average annual rate of return in the S&P500 is roughly 7%. Student debt remains to be one of the largest components of personal debt, both in Canada and the US. Really decide whether studying abroad or going to a more expensive university is worth it for the degree that you are getting. It may not be worth getting certain degrees from an Ivey League school and paying the inflated tuition costs as compared to a non Ivey League university. Do a cost benefit analysis and see what you are really getting out of your degree compared to what you are paying for.
3) Car loans and other loans on non real estate assets
When I say non real estate assets, I’m referring to loans on things like furniture, or golf clubs, or any good purchased from a retailer that offers financing upon purchase. More importantly, however, this category focuses more on vehicle financing. Financing a vehicle and paying interest on a depreciating asset makes no sense whatsoever, and the only winners in these situations are the parties that you owe money to. Focus on expediting your car payments and increasing the periodic monthly payment amounts to get this debt burden off your back. Financing at zero percent is the only case where financing a vehicle makes sense, since this is essentially a free loan. The dealership is trying to incentivize you to buy a vehicle by offering zero percent interest for a period of time. Take the zero percent financing and make the interest free payments for this initial period, and then once the actual interest kicks in, pay off the remaining balance in full! The dealership and the bank will loathe you for it.
The goal is to always have zero outstanding personal debt, or what I like to call the “bad debt”. Good debt comes in the form of financing appreciating assets, like your home. So the last debt item to pay off on my list is the mortgage on your primary residence.
4) Mortgage
I struggle with this one because at 3% interest rates right now, I find it hard to make a case to pay off mortgages faster when market returns average you 7% per year. Also, as mentioned in Lesson 54, your monthly payments and interest portion depends on the down payment initially put down and the mortgage rate agreed upon with the bank. Nonetheless, mortgages come with interest tacked on to every payment, and this interest portion only goes down over time as the remaining principal balance goes to zero. Everyone should have their primary residence completely paid off before retirement to alleviate any financial stress of mortgage debt during a time when you have no more steady income coming in (I know this will not be the case for everyone, as many real estate investors achieve great success through leverage and purchasing other real estate using a line of credit on the primary residence). If you have extra cash lying around, make a lump sum payment towards your mortgage. Many banks offer lump sum payments directly to the principal once or twice a year (usually on the anniversary date of the mortgage term).
Prioritizing debt payment as per these four categories will help expedite one’s debt payment plan and ease the burden of financial obligation off of one’s shoulders. Continued spending discipline and tracking of your budget will help keep you on track of retiring debt free. Because the only thing that should be giving you grey hair in retirement is your natural aging process.