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Paying off your debts; some “do’s” and “don’t’s”

Paying off your debtsHave you made your New Year’s resolution? Recent surveys tell us that paying off your debts is one of the most common resolutions made; and broken. About 25% of people have this as their new year’s resolution; following losing weight, exercising more, and spending more time with family and friends.
It is no wonder that paying off your debts is so popular. Canadian household debt is at all- time highs.

According to the latest data from Statistics Canada, the ratio of household credit market debt to adjusted disposable income crept up to 166.9 per cent in the third quarter, up from 166.4 per cent in the second quarter. That means, on average, Canadians owed $1.67 in credit market debt–mortgages, other loans and consumer credit–for every dollar of disposable income.

Paying off your debts – Before we get into the steps you should take to get out of debt we are going to suggest a number of things you should NOT do:

1. Do not use your RRSP funds to pay down your debt. If the worst happens and you have to file bankruptcy RRSPs are retained by you, whereas the unsecured debt is erased. In some provinces the entire RRSP is exempt and in other provinces the contributions made in the 12 months prior to bankruptcy are clawed back for the benefit of the creditors.

The law makers set up these RRSP exemptions because they want you to keep the RRSPs for your retirement, not for debt repayment.

2. Do not borrow from family or friends to pay down your debts. None of us have so many friends that we can afford to lose some. Remember the words of wisdom from Shakespeare’s Hamlet: Neither a borrower nor a lender be, For loan oft loses both itself and friend,

3. Do not remortgage your house to pay down your debts. In some cases this could be a good strategy but beware of the following:
a. If the house is in joint tenancy (owned by both you and your spouse) remortgaging the home will reduce your spouse’s equity in the home as well as yours.
b. If the worst happens and you have to file bankruptcy this could leave you worst off because in a bankruptcy unsecured debts are erased and a home in many provinces have some of the value exempt. In Alberta and Saskatchewan the home exemptions are $40,000 and $50,000 respectively.

Paying off your debts – The avalanche plan for paying down your debts.

Paying off your debtsThis is the most popular and cost effective way to pay off your debts:
1. Stop using your credit cards. Pay cash for purchases. If you don’t have the cash, save for the purchase.
2. Cut up your credit cards or at least soak them in water and place them in the freezer. This at least, will make it a little more difficult to use them.
3. List all you debt by the interest rate each bears. Highest interest rate to lowest rate.
4. Pay the minimum payment allowable for all the debt except for the highest interest rate debt. On that debt pay the most that is available from your budget.
5. When that debt is paid off go on to the next highest interest rate debt and pay the most that is available from your budget. This is where the avalanche effect comes in as you have more and more money to pay off your debts as each debt is paid off.
It is not easy to follow this plan. It takes dedication and perseverance. However, if you really want to take control of your debt and avoid the high interest rates, this plan will allow you to take back control of your debt and gain your financial freedom.

Paying off your debtsAbout the author: Earl Sands, MBA, CPA, LIT – is a Licensed Insolvency Trustee. He wrote the Personal Insolvency Guide, which was first published by Self Counsel Press and has been sold in stores across Canada. He currently operates one of the best bankruptcy resources on the Internet; Bankruptcy Canada.