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  • Saving your way into poverty? Smart debt management is the answer.

    Saving your way into poverty? Smart debt management is the answer.

    by:
    Laurie Campbell

    Trying to save money is a losing proposition when the interest on the debts you owe far outstrips the interest on the money you are trying to tuck away. You’re swimming against a debt riptide here that’s stronger than the arm strokes you need to get you back to shore. I characterize it as a way of saving your way into poverty through imprudent debt management. Smart debt management means paying debts off as soon as possible to make room for more savings.

    Let’s look at an example of how the process works, keeping in mind that more and more Canadians today are showing little eagerness to pay down debt quickly. 

    In this example, making only the minimum monthly payments, you would spend over $9,700 in interest over almost 25 years to get debt free.

    Say you’re carrying $10,000 in credit card debt even with modest interest of 15 per cent. With a required monthly minimum payment of two-and-a-half percent, you would be paying about $225 per month on the debt. If you kept making only the minimum monthly payments, you would spend almost $9,700 in interest over approximately 25 years to get debt free.

    But let’s say you increased your monthly credit card debt payment to $400. You would retire the debt in less than three years, paying just over $2,000 in interest, representing $8,000 in savings on the interest. Taking this thought further, if after paying off your credit card debt you continued to save $400 a month, you could have about $24,000 in hard cash savings in five years or more depending on the interest rate of your investment.

    Beyond just upping your debt payments, you can create more money-savings space by taking advantage of something called debt consolidation.

    Beyond just upping your debt payments to make room for savings, you can also create more money-savings space by taking advantage of something called a debt consolidation loan – of particular interest to those who are behind the eight ball financially. Investopedia provides insight into debt consolidation through an excellent online article written by Rachel Humenny. The debt consolidation process she speaks of is similar to procedures underpinning the consumer credit counselling services we offer through my agency Credit Canada, though we provide the services on a not-for-profit basis.

    As Humenny points out, debt consolidation “is one way to rid yourself of your debts quickly by combining all your current outstanding loans and liabilities – and their generally outrageous interest rates – into a single debt vehicle with a lower interest rate. Instead of having to pay a number of different lenders each pay period, you take out a new loan to pay off all of the other liabilities and are left with only one, lower interest loan to service, allowing you to pay down your debt more quickly.”

    “Debt consolidation is a tool to help you get out of the doghouse, not to get you a nicer and more expensive doghouse.”

    Humenny offers an example of consolidation savings. “Let's say that you currently have three credit cards that charge twenty eight per cent interest annually, they are maxed out at $5,000 each and you're spending $250 a month on each card to pay them off. If you were to pay off each credit card separately, you would be spending $750 a month for 28 months and you would end up paying a total of $5,441.73 in interest.

    “However, if you transfer the balances of those three cards into one consolidated loan at a more reasonable 12 per cent interest rate and you continue to repay the loan with the same $750 a month, you'll pay one-third of the interest ($1,820.22), and you will be able to pay off your loan five months earlier. This amounts to a total savings of $7,371.52 ($3,750 for payments and $3,621.52 in interest),” she writes.

    Credit Card vs Consolidation Loan

    Humenny emphasizes, however, that debt consolidation “only works if you don't pick up those three credit cards at the end of the day and start spending again. Consolidation is a tool to help you get out of the doghouse, not to get you a nicer and more expensive doghouse.”

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