Lines of Credit versus Personal Loans: Which Should I Choose?

You want to borrow money, but you’re not sure the best way to do it. You know a credit card doesn’t make sense since it will be a large expense that you plan to pay off over an extended period of time. You’re thinking a line of credit or personal loan makes sense, but you don’t know which one is best.

Let’s take a closer look at lines of credit and personal loans and when you might want to choose one over the other.

What’s a Line of Credit and When Might It Make Sense?

Lines of credit are loans that allow you to borrow up to a predetermined limit. A line of credit is quite flexible. You’re able to borrow as much money as you need and pay it back on your own schedule (when you’re approved for an interest-only repayment schedule).

A line of credit is revolving credit. This is just a fancy way of saying that you’re able to borrow against it whenever you want and pay it off on whenever you like without applying for a new loan. Lines of credit don’t have a specific date you’re required to pay them back in full. Instead, you can pay them off on a schedule that works with your finances. (However, the longer you take to pay off your line of credit, the more you’ll pay by way of interest.)

With a line of credit, you can make interest-only payments, making your payments more affordable. Also, you’ll only pay interest on money that you’ve borrowed. (You’re charged interest only on the money you withdraw from your line of credit, not on the credit limit itself.)

Lines of credit can make the most sense for both short- and long-term borrowing needs. For example, if you’re looking to consolidate debt and you may need to borrow more money down the line, a line of credit makes a lot of sense. You’ll be able to borrow more money later on without applying for a new loan.

Likewise, if you’re planning to borrow money for a major expense, such as a costly home renovation, or you’re planning to borrow money on an ongoing basis (i.e. for a serious of home renovations), then those are other instances when lines of credit can make sense.

What’s a Personal Loan and When Might It Make Sense?

A personal loan is a loan in a fixed amount that you agree to pay back over a specific time period by way of instalments. Loans usually need to be paid back over six to 60 months.

Loans are less flexible than lines of credit. If you need to borrow additional funds or you’d like to extend the repayment period, you may need to apply for a new loan.

The monthly payments on loans tend to be higher. Unlike lines of credit where you can make interest-only payments, the payments on loans must consist of interest and principal. Also, unlike a line of credit, you’re charged interest on the total loan amount the moment you take out a loan, regardless of when you use the money.

Loans make the most sense for specific needs, like paying for a vehicle or a one-time home renovation. If you don’t plan to borrow any more money, a loan can make a lot of sense.

A loan is also handy for those who lack financial discipline and prefer a fixed payment schedule. With a line of credit, it can be tempting to make interest-only payments, but by doing that, you’re no further ahead. With a loan, you’re required to make interest and principal payments. Because of that, your minimum monthly payment is higher, helping you pay off the loan sooner and save on interest.

Are you still not sure whether a line of credit or personal loan makes the most sense for you? Contact our offices today. Our credit consultants are happy to help.

Climb’s Personalized Credit Prescription provides you with customized recommendations to help rebuild your credit score.

About the Author

Sean Cooper is the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. An in-demand Personal Finance Journalist, Money Coach and Speaker, his articles and blogs have been featured in publications such as the Toronto Star, Globe and Mail, Financial Post and MoneySense. Connect with Sean on LinkedInTwitterFacebook and Instagram.

Canadian Household Debt on the Rise: What Does it All Mean?

It’s hard to pick up a newspaper these days and not see at least one headline about the elevated debt levels in Canada. If you find yourself in consumer debt, at least you’re not alone. But is all the worry really justified? Is Canadian household debt bordering on excessive or is the fear overblown?

Let’s take a closer look at Canada’s household debt situation and what it all means.

The Debt to Income Ratio Hits a New Record

If we focus on just the facts, the facts don’t lie – Canadian household debt is on the rise. Together we owe $2.16 trillion in debt. As a share of GDP, Canada has the dubious honour of having the highest debt load of the G-7 countries.

How did we as Canadians find ourselves in this situation? Low interest rates for the better part of a decade have encouraged Canadians to go on a borrowing binge.

A popular way to measure household debt is the debt to income ratio. The media loves to use this in attention grabbing news headlines. The debt to income ratio looks at your total debt compared to your income. To calculate your own personal figure, add up all your debts – your mortgage, car loan, line of credit, credit card debt and any other debt you might have – and divide it by your net (after tax) annual income. Multiply that figure by 100 and voila, you have your own debt to income ratio!

As of the fourth quarter of 2018, the average Canadian’s debt to income ratio rose to a record 174%, up from 148% a decade ago.

But there’s no guarantee interest rates will stay low forever. The Bank of Canada has already increased interest rates five times since mid-2017. Although it looks like our central bank has taken a pause with respect to further rate increases, if rates were to continue to rise again in the future, many Canadian families who are already feeling the squeeze from higher interest rates, might feel even more of a squeeze if and when higher interest rates arrive.

Is It All Really So Bad?

At first glance Canada’s debt situation looks pretty dire. While the total debt figure and the debt to income ratio may look scary, those are only two measures of household debt. Another important measure is your ability to service your monthly debt.

To calculate this figure, add up how much debt you have each month. This is debt you’d have to pay even if you were on holidays laying on a beach, sipping an umbrella drink. This includes your mortgage, car payments, minimum credit card payments and minimum student loan payments. Then calculate how much your household brings in on a monthly basis. This includes your salary, your spouse’s salary and any extra income you earn on the side.

Take the debt figure and divide it by your income figure and multiply by 100. Ideally, you want to keep this figure below 40 percent, although if you’re living in a city like Toronto or Vancouver where the cost of living is higher, that number could creep as high as 50 percent (although lower is better). Anything over 50 percent and it should raise the alarm bells. In that case, you should look to cut back on your fixed expenses.

The Bottom Line

When I was paying off my house, my debt to income ratio was almost 450 percent and I was fine. That being said, if your debt to income ratio is high and so is your monthly debt figure, then that should be an area of concern.

Confused about these numbers? Contact us today. We’re happy to walk you through them and help you get on the right financial path.

Climb’s Personalized Credit Prescription provides you with customized recommendations to help rebuild your credit score.

About the Author

Sean Cooper is the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. An in-demand Personal Finance Journalist, Money Coach and Speaker, his articles and blogs have been featured in publications such as the Toronto Star, Globe and Mail, Financial Post and MoneySense. Connect with Sean on LinkedInTwitterFacebook and Instagram.

What’s a Consumer Proposal and How’s it Different from Bankruptcy?

If you’re like most Canadians, you’re probably familiar with the term consumer proposal, but do you understand what it truly means? Many of us use consumer proposal and bankruptcy interchangeably. While both are similar with respect to how they help you get rid of debt and put you in a better position from a monthly cash flow perspective, the way that each of them achieves this is different.

Let’s take a look at what a consumer proposal is, how it works and the benefits of filing a consumer proposal over filing for bankruptcy.

What’s a Consumer Proposal and How Does it Work?

A consumer proposal is a formal arrangement that’s negotiated with creditors that you owe money to. This legally binding agreement is negotiated and administrated by a Licensed Insolvency Trustee (LIT). A consumer proposal is another way to handle debt besides filing for bankruptcy. It protects you from your creditors seeking immediate debt collection, sometimes via legal action.

When filing a consumer proposal, you’ll want to work with an experienced LIT that you can trust. The LIT and you will work closely together to come up with a proposal that your creditors are likely to accept. At its heart, the consumer proposal will pay creditors a percent owing to them, lengthen your payment schedule or a combination of both. (Please note that your consumer proposal can only be stretched out to five years at a maximum.)

When filing a consumer proposal, instead of paying creditors directly, you’ll make the payments through the LIT you’re working with. The LIT will then pay the creditors based on the agreed upon repayment schedule and amount in the consumer proposal.

What are the Benefits of Filing a Consumer Proposal?

Considering filing for bankruptcy and a consumer proposal and not sure which one to go with? Here are some benefits of filing a consumer proposal.

Not Filing for Bankruptcy. A major benefit of filing a consumer proposal is you’re not filing for bankruptcy. Creditors will usually accept the consumer proposal you develop with the LIT if they believe they’re likely to be paid more than they would receive under a bankruptcy.

But filing a consumer proposal isn’t just a benefit for creditors, it can be beneficial to you. Consumer proposals don’t tend to affect your credit score in as much of a negative way as bankruptcies do. Consumer proposals results in a R7 rating on your credit report, while bankruptcies result in the worst credit rating, an R9.

Better Cash Flow. Since the amount of time you have to repay your debts may be stretch out or the amount you’re required to repay lessened, your cash flow is almost always improved. Interest also stops accruing the moment you file the consumer proposal, helping you save on the total amount of interest you’ll pay.

Keep Your Assets. One of the biggest worries about filing for bankruptcy is losing the assets you’ve worked so hard for over your life. We’re talking about your home, car and other worldly possessions. Unlike a bankruptcy where you could have to turn over the keys to your home and car, in a consumer proposal those assets are typically protected from being seized by creditors.

This was a brief overview of what a consumer proposal is and how it’s different from filing for bankruptcy. Thinking about filing a consumer proposal? Speak with one of our experts to see if it makes sense for you.

About the Author

Sean Cooper is the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. An in-demand Personal Finance Journalist, Money Coach and Speaker, his articles and blogs have been featured in publications such as the Toronto Star, Globe and Mail, Financial Post and MoneySense. Connect with Sean on LinkedInTwitterFacebook and Instagram.

How to Prepare for your Next Mortgage

With the spring homebuying season fast approaching, anyone committed to buying a home in 2019 needs to start preparing. That can be a pretty daunting task, especially if you’ve never taken out a mortgage before. With all the rules, steps and considerations, buying your first home is like taking a crash course in the real estate industry.

But when you break it down, applying for a mortgage isn’t as complicated as it might first appear. Follow these four steps to prepare your finances and the rest will fall into line.

Evaluate your Credit

Having a good credit score is one of the best ways to qualify for a mortgage with favorable terms. Without solid credit, a bank may charge higher interest rates or deny your application outright.

Check your credit report or your credit score through a free service to see where you stand.

Make sure there are no errors on your report that could disqualify you for a mortgage.

See if there are any red flags from your past that may be disputable. Negative marks generally stay on your credit report between six and seven years, so call the credit bureau if you see any older than that.

Save for a Down Payment

If you haven’t started, now is the time to create a savings plan for your down payment. A down payment acts as proof of trustworthiness to the lender, so it’s a great way to establish yourself as a qualified borrower. You need to put down at least 5% for a mortgage, but a 20% down payment will save you from paying private default insurance.

How much you want to contribute depends on your budget and how soon you want to buy. If you want to purchase a home next year, you might not have time to save the full 20%.

Remember to also save money for closing costs, moving expenses and new furniture. Buying a home for the first time can come with a lot of surprise expenses, so it never hurts to save more than you’ll probably need.

Pay Down Debt

Lenders determine how big of a mortgage to offer based on your income and current debt load. The more you owe, the less you’ll qualify for.

Before buying a home, see if you can pay off high-interest debt or refinance to a lower monthly payment. Reducing your total debt burden will free up your finances and make it easier to qualify for the mortgage you want.

Look at your Budget

Borrowers often use their current rent payment to determine the size of the mortgage they want, but owning a home is far more expensive than renting. On top of the mortgage payment, you have to pay for repairs, maintenance and property taxes. When the water heater breaks, there’s no landlord to step in and handle the repairs.

Assess your budget and see how much wiggle room you have for the unexpected costs. If your monthly spending is already tight, consider getting a house with a monthly payment less than your rent. You can use the remainder to save for future repairs and other home costs.

About the Author

Zina Kumok is a trained journalist and has covered everything from professional sports to murder trials. Now, she specializes in personal finance and has written for brands and publications such as Mint, Investopedia and Discover. She paid off $28,000 worth of student loans in three years.

Poll Finds Almost Half of Canadians are $200 Away from Insolvency

January 21st was Blue Monday. In case you’re not familiar with the term, Blue Monday is a name given to the supposed most depressing day of the year. If the sun setting before 5pm and the cold weather outside doesn’t dampen your spirits, getting your holiday credit card statement in the mail might just do it.

To coincide with Blue Monday, insolvency firm MNP released its latest poll with some eye-opening findings.

A Third of Canadians Don’t Make Enough to Cover Bills and Debt Repayment

MNP’s poll found that 46 percent of Canadians are $200 or less away from financial insolvency. That’s up from 40 percent the last quarter. Furthermore, 31 percent of respondents feel that they don’t earn enough to pay the bills and meet debt obligations. That’s up seven percent from last quarter.

With the Bank of Canada raising interest rates five times since mid-2017, Canadians are feeling the pinch. No more so than those living on the financial edge. The poll found that 51 percent of Canadians are feeling financially pinched by higher interest rates. That’s up from 45 percent the previous quarter.

These are some quite startling findings. It shows that Canadians aren’t saving enough for a rainy day. Any unanticipated increase in the cost of living or interest rates could push them over the financial edge.

Canadians Going into Debt to Pay the Bills

Canadians are a resilient bunch. Instead of filing for bankruptcy or a consumer proposal, they’ll use every tool at their proposal to pay for day to day living expenses. One of those tools is going into debt. The poll found that 45 percent of Canadians said they would need to go into debt to pay living and family expenses.

Higher living expenses aren’t the only concerns of Canadians. Further interest rate increases are a worry, too. Half of Canadians say that they would find themselves in financial trouble if interest rates keep rising. That’s up five percent from last quarter.

Higher living costs coupled with higher interest rates could put some Canadians in a real financial bind. The cost of living will most certainly keep rising. The only question is when will interest rates rise. If it ends up being sooner rather than later, it could impose a lot of financial pain on some Canadians.

Protecting Yourself from Higher Interest Rates

If you  have consumer debt, it’s important to come up with a plan of attack. As I mentioned in an earlier article, the debt avalanche and debt snowball methods can both be effective for paying down your debt. Likewise, you might want to look into getting a consolidated loan at a lower overall interest rate. Once you have your debts under control, your next focus should be building an emergency fund. Financial experts recommend saving three to six months’ living expenses in a savings account. Coming up with that much money at once can be tough, so start saving $200 per month or whatever you can afford and you’ll have a full funded emergency fund before you know it.

About the Author

Sean Cooper is the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. An in-demand Personal Finance Journalist, Money Coach and Speaker, his articles and blogs have been featured in publications such as the Toronto Star, Globe and Mail, Financial Post and MoneySense. Connect with Sean on LinkedInTwitterFacebook and Instagram.

How to Travel This Winter and Not Break the Bank

Winter is the coolest time of year and perhaps the most polarizing of all the seasons. Some people love winter time, while others (aka snowbirds) can’t wait to plan a getaway to a warmer place. It should then come as no surprise that airline tickets tend to be the priciest during wintertime, since many of us can’t wait to escape the colder weather.

So, how can  you travel this winter without breaking the bank and derailing your financial goals? Let’s take a look at some simple ways to save on travel during the cooler months.

Visit Less Touristy Places

When you think of winter travel, warm places like Miami, L.A. and Jamaica are probably first to come to mind. But you’re not the only one who wants to go there. These are among the most popular tourist destinations. That means spending megabucks on airline travel. There’s nothing stopping you from visiting a warm place without breaking the bank.

So, you want to go to Miami? How about going to Gulf Coast of Florida? The airline tickets will most likely be a lot cheaper and you won’t have to deal with the large crowds of Miami. Want to go to L.A.? Try San Diego instead. Want to go somewhere in the Caribbean? Instead of Jamaica, try Puerto Rico or the Dominican Republic. Both are affordable alternatives.

Travelling Within Canada

Not too fond of laying on a sandy beach? Would you rather be hitting the slopes? Whistler is a popular destination for skiers, but did you know there’s a more affordable alternative? Banff is worth a visit during winter. Winter is considered busy season at Whistler, while it’s slow season at Banff. You’ll be able to get access to the best ski hills in Banff and pay a fraction of the cost you’d pay in Whistler.

Be on the Lookout for Deals

Don’t wait until the last minute to book your trip. Start planning well in advance. You’ll be more likely to get the best deals on airline tickets. You can use a tool like Google Flights to monitor the prices and find the cheapest flights. Sign up for travel newsletters and keep an eye out for deals.

Consider planning an all-inclusive vacation. Not only will you be able to save time planning your trip, you may save money, too.

March and spring breaks are peak times for travel. Try to avoid booking a trip during this time. Ditto for flying out on weekends (especially Family Day long weekend). Flying out on a weekday or taking a redeye flight can help you save on your airline ticket.

By planning in advance you can save yourself big bucks on winter your trip. Don’t wait until there’s a foot of snow outside to plan you trip. Start planning in the summer or fall for the best deals on winter travel and keep more of your hard earned money in your pockets where it belongs.

About the Author

Sean Cooper is the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. An in-demand Personal Finance Journalist, Money Coach and Speaker, his articles and blogs have been featured in publications such as the Toronto Star, Globe and Mail, Financial Post and MoneySense. Connect with Sean on LinkedInTwitterFacebook and Instagram.

Take Control of your Finances in 2019

Everyone wants to make big change in the new year. We want to quit smoking, start reading more novels and stop spending so much time on our phones.

But many of us also want to use the new time as an excuse to fix our finances. If you spend most of your days avoiding your bank account balance or refusing to open your credit card bills, then make 2019 the year you change.

Here are the best ways to take control of your finances in 2019:

Start Tracking Your Expenses

The most basic way to control your finances is to track how you spend money, whether it’s a $3 croissant or a $300 TV. Tracking your money will notify you of any trends in your life and help you find your financial weak spots. There are many apps available you can use to track or simply track on a spreadsheet or journal.

After you’ve tracked expenses for a while, you can start a budget or plan to minimize your spending and maximize your savings.

Create a Debt Payoff Plan

If you have any non-mortgage debt, make 2019 the year you finally tackle it. Make a list of what you owe including credit cards, student loans, car loans and personal loans. If you have extra discretionary income, decide how you want to conquer your debt.

There are two debt payoff methods: the snowball and the avalanche. The avalanche means paying off debt in order from highest interest rate to smallest. This strategy will decrease how much you pay in total interest.

The debt snowball method encourages people to make extra payments on the smallest balance first. When you do this, you’ll pay off individual debts faster and gain more momentum.

Shore Up Your Retirement Accounts

Most of us have no idea how much we have in our retirement accounts or how much we need to save. The best action you can take in 2019 is to determine how much is in your retirement accounts and if you need to do more.

List all your retirement accounts including your RRSP and TFSA and their current balances. Note any pensions that you might receive in the future and what you need to qualify for those.

Start Estate Planning

One personal finance topic that people usually ignore is estate planning. No one wants to think about their death or their spouse’s, so they ignore it. Unfortunately, avoiding the problem doesn’t make the process easier.

If you’re married or have a family, now’s the time to create a will. A will can speed up the probate process and prevent any snags when distributing assets.

If you don’t want to hire an estate lawyer, you can use a service like LegalZoom to create a will for a fraction of the price. Make sure to be thorough as possible when creating a will and list all of the assets you have. If possible, go through all your accounts and designate a beneficiary. That will also accelerate probate.

About the Author

Zina Kumok is a trained journalist and has covered everything from professional sports to murder trials. Now, she specializes in personal finance and has written for brands and publications such as Mint, Investopedia and Discover. She paid off $28,000 worth of student loans in three years.

3 Bankruptcy Myths Busted

Have you ever heard of the TV show MythBusters? Well we’re going to do some “myth busting” of our own with respect to bankruptcy.

With household debt near a record level and interest rates on the rise, it should come as no surprise that Canadians are becoming increasingly worried about debt. In an Ipsos survey, one in three Canadians admitted to fearing bankruptcy. Millennials are finding themselves the most concerned. 62% are concerned about paying their bills, while 46% are worried about being pushed into bankruptcy.

With financial literacy lacking in this country, bankruptcy isn’t something most Canadians know very much about. It’s only when you’re on the brink of it that it becomes top of mind. With that in mind, here are three bankruptcy myths busted.

1. Filing for Bankruptcy Erases Your Student Loan Debt

Most employers these days are demanding more education. In our parent’s generation, you could often get by with just a high school diploma, while these days in many fields you need an undergraduate degree at a bare minimum.

Imagine you do everything right: you go to university, get straight A’s and graduate top of your class. The problem is that it’s in a field that’s not in demand. Instead of graduating with a well-paying job waiting for you, you’re left with a crippling level of student debt and no way to pay it off. Don’t think this could happen? It happens more often than you think.

If you were thinking about filing for bankruptcy to forgo paying back your student debt, I hate to break it to you, but you’re out of luck in most cases. While are sometimes when you can get out of paying back your student debt, you’ll need to jump through a lot of hoops to do so.

Similar to death and taxes, repaying your student debt is almost a certainty in life. If your student debt is under seven years old, then you’ll still be on the hook for repaying it even after you file for bankruptcy. The only option may be to apply for the repayment assistance program to lower your payment, but your student debt will still be there, so choose wisely a university program with good job prospects rather than a big mound of student debt waiting at the end.

2. Only Reckless Spenders File for Bankruptcy

Like it or not, there’s a negative stigma with bankruptcy. There’s a general belief out there that only reckless spenders file for bankruptcy, when that couldn’t be further from the truth.

I recently interviewed Ben Le Fort for my Burn Your Mortgage podcast whose parents, who were successful real estate agents, were forced to file for bankruptcy when the 2008 financial crisis happened and they didn’t have any emergency savings.

Sometimes life circumstances can throw you a curveball. You could lose your job, get sick or your partner could suddenly pass away. That’s why it’s so important to have an emergency fund. Three to six months’ living expenses should suffice, depending on the stability of your job. But that’s a lot to save if you don’t have any savings, so start small. Save whatever you can afford – $25 or $50 a week – to start. You’ll have a sizable emergency fund before you know it.

3. The Insolvency Trustee You Go With Doesn’t Matter

When you’re hiring a real estate agent, you wouldn’t hire the first one that you meet (at least I hope not). You’d take the time to interview at least two or three agents before making your final decision. The same holds true with trustees.

Choosing an insolvency trustee is kind of like picking a lawyer. The trustee you end up working with can have a huge impact on how your bankruptcy is handled and how your financial future plays out.

There are over 900 licensed insolvency trustees in Canada. Each one may interpret the Bankruptcy and Insolvency Act differently. Taking the time to interview at least a couple is time well spent. These are just three bankruptcy myths. Thinking about filing for bankruptcy? Speak with one of our experts to see what makes the most sense for you.

How much money is ideal to pay towards Visa #2? Personal finance is very personal, so it depends on your own personal situation. Creating a budget is a good first step to see how much you can comfortably afford to put towards paying off your debts.

Are you motivated to pay off your debts that much sooner? Go on the offense with your finances by bringing in extra income or go on the defense by cutting expenses. For example, if you’re a good photographer, you could be a wedding photographer in your spare time. Likewise, if you’re looking to save money, instead of buying lunch every day at work, you could pack your lunch once or twice a week.

The Debt Snowball Way

The second effective way to rid yourself of your debt is the debt snowball way. The debt snowball way is slightly different than the debt avalanche way. Instead of focusing on the debt with the highest interest rate, you’d focus on paying off the debt with the smallest balance. This may be the same credit card as the one with the highest interest rate or it may not be. It really depends.

Using the same example, if Visa #1 has an outstanding balance of $1,000 and Visa #2 has an outstanding balance of $4,000, with the debt snowball way you’d pay off Visa #1 first. (You’d of course still keep making the minimum payments on Visa #2 to keep your credit in good standing.)

I know this may seem counter intuitive and from an interest savings perspective, the debt snowball way doesn’t make sense, but debt repayment isn’t just about dollars and cents. It’s about doing something that motivates you to take action. If the debt snowball way motivates you the most, more power to you.

In the end, there’s no single right way to pay off  consumer debt. I’d encourage you to choose the way that works best for you, setting yourself a goal of when you’d like to pay off your debt and putting a plan in action. By creating a plan and sticking to it, you’ll drastically improve your chances of reaching your goal of debt freedom that much sooner.

About the Author

Sean Cooper is the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. An in-demand Personal Finance Journalist, Money Coach and Speaker, his articles and blogs have been featured in publications such as the Toronto Star, Globe and Mail, Financial Post and MoneySense. Connect with Sean on LinkedInTwitterFacebook and Instagram.

How to Pay Off Consumer Debt: Debt Avalanche vs. Debt Snowball

Who doesn’t love the holidays? It’s a great time to kick back, relax and enjoy some quality time with those nearest and dearest to you.

While there’s a lot to love about the holidays, something that a lot of us dread is opening our credit card statements in January. Many of us take an “out of sight, out of mind” approach. The problem is that this can lead to something I like to call “bill shock” in January, when we open our credit card statements and find out we ended up spending way more than we intended to spend on the holidays.

Starting the new year in debt isn’t fun, but if you find yourself in this situation, there’s no need to panic. Here are two tried-and-true strategies for paying off your consumer debt.

The Debt Avalanche Way

With the debt avalanche way, you start by paying off the debt that’s costing you the most – the debt that has the highest interest rate. For example, if you have two credit cards, Visa #1 with an 18% interest rate and Visa #2 with a 28% interest rate, using the debt avalanche way, you’d focus on paying off Visa #2. (Don’t forget to keep paying the minimum payment on all your other credit cards, otherwise you could hurt your credit score.)

How much money is ideal to pay towards Visa #2? Personal finance is very personal, so it depends on your own personal situation. Creating a budget is a good first step to see how much you can comfortably afford to put towards paying off your debts.

Are you motivated to pay off your debts that much sooner? Go on the offense with your finances by bringing in extra income or go on the defense by cutting expenses. For example, if you’re a good photographer, you could be a wedding photographer in your spare time. Likewise, if you’re looking to save money, instead of buying lunch every day at work, you could pack your lunch once or twice a week.

The Debt Snowball Way

The second effective way to rid yourself of your debt is the debt snowball way. The debt snowball way is slightly different than the debt avalanche way. Instead of focusing on the debt with the highest interest rate, you’d focus on paying off the debt with the smallest balance. This may be the same credit card as the one with the highest interest rate or it may not be. It really depends.

Using the same example, if Visa #1 has an outstanding balance of $1,000 and Visa #2 has an outstanding balance of $4,000, with the debt snowball way you’d pay off Visa #1 first. (You’d of course still keep making the minimum payments on Visa #2 to keep your credit in good standing.)

I know this may seem counter intuitive and from an interest savings perspective, the debt snowball way doesn’t make sense, but debt repayment isn’t just about dollars and cents. It’s about doing something that motivates you to take action. If the debt snowball way motivates you the most, more power to you.

In the end, there’s no single right way to pay off  consumer debt. I’d encourage you to choose the way that works best for you, setting yourself a goal of when you’d like to pay off your debt and putting a plan in action. By creating a plan and sticking to it, you’ll drastically improve your chances of reaching your goal of debt freedom that much sooner.

About the Author

Sean Cooper is the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. An in-demand Personal Finance Journalist, Money Coach and Speaker, his articles and blogs have been featured in publications such as the Toronto Star, Globe and Mail, Financial Post and MoneySense. Connect with Sean on LinkedInTwitterFacebook and Instagram.