What Is Credit Card Debt And How Does It Affect Canadians
Its as simple as it sounds credit card debt is simply the total of all outstanding balances on your accounts. As credit card debt builds, it can negatively impact your credit score and your future ability to qualify for additional credit such as credit cards, mortgages or other kinds of loans. And if youre paying off debt, that means less cash available for your everyday needs.
If this is an area of life youre struggling with, youre not alone. Many Canadians owe money to lenders of all kinds. Not only can this be expensive if your debt has grown to an unmanageable amount, but it can also add up to tons of stress.
Option : Pay Off The Smallest Debt First
Key advantages: Helps build motivation and encourages you to stick with the plan.Key drawbacks: It may take longer to become debt-free and you could pay more in interest.Best for: People who struggle to stay motivated with paying off debt.
While some people choose to address their debt based on interest rate, others pay off their smallest debt first and work their way up to the largest one. This debt repayment method, popularized by financial guru Dave Ramsey, is called the debt snowball because it starts small and grows over time.
The snowball method works because paying off a debt in full incentivizes you to keep working toward your goal and as you pay off your smaller debts one by one, youll have more money to put toward your larger debts. You might end up paying more in interest than you would have paid if you tackled your highest-interest debt first, but the psychological benefits of getting those smaller debts paid off as quickly as possible can be very rewarding.
To get started with your debt snowball, list all of your current debts and their current balances from low to high. Continue to make the minimum monthly payment on all of your debts while putting as much extra money as possible toward your smallest debt. Once that debt is paid off, put your extra money toward your next-smallest debt, and so on. The bigger you build your debt snowball, the closer youll get to debt freedom.
Make Your Payments On Time
You can choose to pay your balance in different ways including:
- in person at a branch
The payment method you choose can affect how quickly it’s processed and the date it’s considered paid. The time it takes to process your payment will vary depending on your financial institution and the payment method you choose. Make sure you know when your payment will be processed to avoid making a late payment.
Contact your credit card issuer to find out how long it takes to process different payment methods.
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Start By Determining Which Debts Are Good And Which Ones Are Bad
Owing money is never a good thing. But in the world of credit scores and money lending, some debts are better than others. Specifically, mortgages, business, and student loans are thought of as good debts because theyre investments in yourself or an asset.
While good debts obviously have to be paid off, they shouldnt be given priority. Put your good debts on the back burner and focus instead on your bad debts. However, continue making minimum payments on your good debts.
Bad debt pretty much constitutes everything else, including personal loans, credit card debt, car loans, and pay advance loans. This isnt the type of debt youll ever be rewarded for having, which is why you should tackle it first.
To get started with your debt repayment plan, make a spreadsheet that includes:
- The amount of each debt
- The type of debt
- Individual interest rates
- The credit limit
- The term
How Payments Are Applied To Your Balance
If you dont pay your entire credit card balance by the due date, youll pay interest.
Different interest rates may apply to different types of credit card transactions. For example, cash advances often have a higher interest rate than purchases. This means different interest rates will apply to your balance depending on how you use your credit card.
Typically, your minimum payment will apply it to the portion of your balance with the lowest interest rate. Any amount you pay over the minimum payment applies in one the following two ways:
- to the portion of the balance with the highest interest rate
- proportionally to the entire balance
A credit card issuer that is a federally regulated financial institution can decide how it will apply your minimum payment to your balance.
Check your credit card agreement or ask your credit card issuer how it applies a payment to your balance.
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How Paying Off The Highest
In some situations, though, paying off the debt with the highest balance may make the most sense.
For instance, perhaps you’re focusing on debt payoff because you’re hoping to qualify for a mortgage or other loan in the near future. Reducing your balances fast and limiting your credit utilization could become your top priority, rather than saving money on interest. In that case, you’d attack the highest balance rather than the debt with the highest rate.
Here’s why: Credit utilization is the amount of debt you carry when compared with your credit limit. It’s the second most important factor in your credit score after payment history, which means it can have a significant impact on whether you’ll get approved for a loan in the future.
Experts recommend keeping your credit utilization to 30% or less at all times, but the lower, the better. So, if your credit limit is $10,000 on the card with a $6,000 balance, for instance, your credit utilization rate would be 60%. To qualify for a mortgage, your best bet would be to pay down that balance ASAP and get your credit utilization below 30%.
At the same time, your credit limit might be far higher on the card with the highest balance, meaning your credit utilization rate could be minimal. Take a look at all your cards’ limits and focus on bringing down the balance on the card that’s closest to its max.
How To Tackle Your Loans
Once youve determined your strategy, its time to take action. Whether you choose the snowball method, the avalanche method, or the 30% method, put a plan in place and be prepared to take action.
As youre paying off your debts, consider refinancing the loans that have the highest interest rates. You can take out a low-interest loan to pay off multiple high-interest loans at once. Then youll have one low-interest loan to make payments on each month.
If youre thinking about refinancing, Monevo can shop more than 30 lenders at once with just one quick form. In just 60 seconds, youll have multiple quotes to choose from. Since theres no obligation, if you dont see a rate substantially lower than what youre already paying, you can exit out and stay with your existing loan.
A great debt consolidation option is Fiona. Like Monevo, Fiona is a loan aggregator that lets you shop multiple lenders at once. With partners like LendingClub Bank, Prosper, and SoFi, youll know youre getting some of the best rates available.
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When You Should Pay Your Credit Card Bill
One of those is to make several payments throughout the month. Another is to immediately pay off large purchases. Both are valid, but remember that however you decide to make your payments, the most important thing is to be sure payments in full are received by the date theyre due each and every time.
If youre planning to apply for new credit within a few months, remember a very large purchase can affect your score quickly by increasing your credit utilization. In that case, paying off that purchase immediately might be the prudent thing to do. You will have the money available, right?
Should I Pay Off Big Debt Or Small Debt First
Whether you should pay off big debt or small debt first depends on your psychological makeup. Studies have shown that paying off small debts often leaves people feeling more satisfiedsmall victories, so to speakand more likely to keep on with a repayment program that eventually clears all their outstanding balances. Certainly, you get quicker results paying off the small debt, and it simplifies life, to have fewer bills coming in each month.
On the other hand, paying off big debt is more cost-efficient in the long run. The larger your outstanding balance, the more interest it’s generating in fact, a big percentage of your monthly minimum payment is probably going just towards the interest. So, by settling the big debt, you will save on interest, and you will free up funds for other bills and other purposes.
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Two Exceptions To The Rule
The rule is based on the fact that the cost of debt is usually much higher than the benefit gained from savings. Therefore your pocket gains more by getting rid of the debt than starting to save. The exceptions are in the few occasions when debts are cheaper than savings, or cost so much to pay off that there’s no point:
The penalty exception. If you’re locked into the debt, so that paying it off incurs a penalty, as with some loans or mortgages, then leave the cash sitting in a savings account until the penalty’s small enough that it doesn’t matter.
There are a number of products where this is possible: introductory 0% credit card offers , 0% overdrafts and Student Loans .
Ask Yourself Which Card Charges The Most
While credit card debt can be overwhelming especially when you have a balance on multiple cards there are some tried and true methods that can help you pay debt off as quickly as possible.
As a first step, find out how much each card charges in interest, expressed as APR, or annual percentage rate, says Alicia R. Hudnett Reiss, certified financial planner and founder of Business of Your Life, a Washington, D.C-based financial planning service.
Then you can use a debt payoff calculator to determine which credit card balance is costing you the most. Write down each of your cards total balances, interest rates, and monthly payments then you can use the calculator to see how much of your payment goes toward interest versus your principal balance.
For example, plugging in the below figures into this calculator:
- 18% APR
- $75 goes towards interest, and only $25 goes towards the principal balance.
- The total interest paid will be $4,311.18
- It will take 7.8 years to pay off the balance
Most people dont actually look at the interest rate on their cards, says Hudnett Reiss. Often, people charge purchases to credit cards to spread the cost out over a few months, without realizing that costs can balloon as the balance sits unpaid and accrues interest.
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You Should Pay Off These Types Of Debts First
Kirsten Rohrs Schmitt is an accomplished professional editor, writer, proofreader, and fact-checker. She has expertise in finance, investing, real estate, and world history. Throughout her career, she has written and edited content for numerous consumer magazines and websites, crafted resumes and social media content for business owners, and created collateral for academia and nonprofits. Kirsten is also the founder and director of Your Best Edit find her on LinkedIn and Facebook.
There are few things as disheartening as finding yourself under a massive amount of debt. Unfortunately, thats an experience many consumers have, whether its maxing out credit cards or financing a new home. So, if you have a few extra dollars in your bank account, you should use them to pay down your loans ahead of schedule, right?
In reality, choosing to eliminate your debt is not so clear-cut. Though some loans are inherently toxic to ones financial picture, other forms of credit are relatively benign. When you consider the alternate ways in which you can spend your excess cash, it might do more harm than good to use it to pay more than your monthly minimum.
Best Strategies To Pay Off Multiple Credit Cards
If you can afford to do so, stop using your credit cards.
This may not be possible for everyone. After all, you still have to put food on the table and pay your bills. If you cant cut your credit card use altogether, take a look at your budget and consider using your debit card instead whenever possible.
Additionally, consider at least one of the following options that might help you take control of your debt.
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Avoid Debts Piling Up
The minimum payment on a credit card is the lowest amount a customer can pay. Although keeping up to date with payment deadlines should be the priority, its advantageous to avoid getting stuck in a cycle of just paying the minimum every month.
Carrying credit card balances forward can make it difficult to clear debts, especially if youre spending more at the same time as paying the minimum amount. As your balance increases, the interest fees will rise, and you could get into a spiral.
You might find that your debts pile up to a point where you cant make a significant dent in the balance. If you have the funds available, its best to try to clear your balances as soon as possible.
Banks Love Us To Save And Have Debts
Put most simply, when you save money you’re actually lending your cash to the bank for it to lend on to other people. The difference between the rate at which it borrows money from you and the rate it charges others is its profit. Therefore, on the whole, it’ll always cost more to borrow than you can earn by saving.
This is why I find it deeply frustrating that many people have both borrowings and savings at the same time, often with the same bank. Essentially the bank is lending you back the money you lent it, except charging you much more.
Think about this, it’s actually quite shocking. I once made a speech to the Building Society Association conference, which was puffing out its chest at how much better than banks they were.
So I asked how many of their savings managers’ salaries were based on the value of savings they brought in. Many were. Then I questioned how many got the branch staff to ask people opening savings accounts if they had debts. Not one!
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Paying Early Also Cuts Interest
In general, we recommend paying your credit card balance in full every month. When you pay off your card completely with each billing cycle, you never get charged interest. That said, it you do have to carry a balance from month to month, paying early can reduce your interest cost. That’s because the interest you’re charged is based on your average daily balance.
Say you come into a month with a $1,000 balance on your card. If you paid, say, $400 of that balance on the last day of the month, your average daily balance for the billing period would be about $987. If your credit card had a 15% interest rate, your interest charge for the month would be about $12.33.
Now say you paid that same $400 halfway through the month. In that case, your average daily balance would be $800 and your interest charge would be $10. You cut your interest payment by about one-fifth just by moving up your payment date.
Which Loan Should You Pay Off First A Guide To Tackling Your Debt
Modified date: May. 12, 2021
Theres nothing more satisfying than paying off a loan and closing a debt chapter of your life. At the same time, sometimes paying off debt requires a strategic approach, which can make it difficult for you to determine in what order you should tackle your debts.
With that in mind, heres what I know about debt-reduction strategies and choosing what loan to pay off first.
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Which Debts Should You Pay First
Heres a bold statement for you: debt levels dont matter.
Because its not the level of debt that causes the problem necessarily. Its whether or not you can service it.
On our year-end review show #174, we gave the example of someone with a $500,000 mortgage and 25-year amortization. If the interest on it went from 3.29% to 4.29%, the monthly payment would go from $2,400 to just over $2,700. Thats about an 11% increase. Would you be able to afford an 11% increase? Would your salary go up by that much? If you can afford it, then great.
Its not the actual debt amount that matters. Its your ability to keep paying it down, especially when interest rates go up.
Which Debt Should You Pay Off First
There is rare agreement among financial experts that consumers facing multiple credit card balances should focus their extra effortand fundson one debt at a time, and after that debt is paid off, put any extra funds toward the next debt on the list, and so on.
While we all think this is the wisest plan for paying down multiple balances, there is much debate about how the debts should be prioritized:
- Debt Snowball: The popular debt snowball method says you should pay smallest balances first. Once the smallest debt is wiped out, put any extra funds to the next smallest, and so on. The last debt to be repaid will be the one with the highest balance. This method creates momentum and eliminates debts more quickly up front as the first few small debts are paid off.
- Debt Snowflake: This is a variant of the snowball, where you make multiple payments every month. So every debt gets the minimum payment, then you make extra small payments every week to the one with the smallest balance. It has the same effect as the snowball, but youre spreading out the payments for budgetary reasons.
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