How to Get Out of Debt Faster
Updated: Oct 16, 2021
Millions of Canadians struggle with gaining control over their finances and how to get out of debt faster. According to their recent survey, MNP Debt Licensed Insolvency Trustees report that the Canadian consumer debt index is at its highest level in three years. According to MNP, this quarterly index “tracks Canadians’ attitudes toward their consumer debt and gauges their ability to pay their bills, endure unexpected expenses, and absorb interest-rate fluctuations without approaching insolvency”.
Debt continues to surge among Canadian households throughout the pandemic as interest rates have dropped to their lowest levels in history. The average Canadian household now has $1.70 of debt for every dollar of annual income. It’s no surprise that many are feeling the increasing pinch of debt and are trying to find ways to get out of debt faster. This article will explore strategies to put you in control of your debt and put you onto a path towards being debt-free faster.
Create a Budget
If you’re like many Canadians trying to keep up with the rat race, always trying to earn more income, you're missing an important variable in your finances; monthly spending. The first step towards paying off your debt is to begin taking control of your expenses. Creating a monthly budget is one of our top money-saving tips because it works.
A budget is a guide on how you want to spend your hard-earned money each month. The simple fact is that a dollar saved is worth more than a dollar earned. The reason for this fact is simple. Taxes. If you earn an extra dollar, that dollar is subject to tax. Hence, you will only receive a part of that additional income. Yet if you save a dollar by budgeting, the whole dollar adds up as savings. You can use these extra savings to pay off debt faster.
This article doesn't cover how to create a budget, but you can check out one of our most popular articles How to Create a Budget and Save Money here. You can also kick-start your budgeting by downloading our free budget planner.
Consolidate Your Debts
One effective strategy to pay off your debt faster is to consolidate high-interest debts into a single low-interest loan. The best way to consolidate all of your debts is through a mortgage refinance. Refinancing your mortgage involves taking out a new loan at a higher amount and paying out the existing mortgage. The additional funds go to pay off existing loans, credit cards and lines of credit.
The reason this money-saving tip is so effective is that we are experiencing the lowest interest rates in history. Since the mortgage interest rates are lower than credit cards and lines of credit, more of your monthly payment goes towards paying off the debt and less of the repayment goes towards interest. This fact ensures you pay off debt faster.
Don’t own your home? There are debt consolidation loans for every type of circumstance. Many companies offer consolidation loans to help you pay off high-interest credit cards and lines of credit.
Debt consolidation loans can have higher interest than credit cards and lines of credit. Keep in mind that lenders calculate these loans over shorter periods (usually 5 to 10 years). Paying your debt over a set time frame ensures you pay off debt faster and with less interest. Currently, making the minimum payment on a $10,000 credit card balance at 19.99% interest can take you over 14 years to pay off!
Negotiate with Creditors
If your debt is too burdensome and you’re having challenges keeping up with payments, the simplest solution may be bargaining with your creditors. There are several ways how to pay off debt faster by working with creditors. Always seek advice from a licensed insolvency practitioner before proceeding with one of the solutions below.
File for bankruptcy
Although this option is an extreme one, it may be the only alternative if you have large amounts of debt that you cannot repay. Filing for bankruptcy can damage your credit for many years and can be challenging to overcome, yet it may be the best solution for you.
A bankruptcy involves requesting an injunction from the courts to stop all collection attempts by creditors and determine an appropriate settlement. The judge enforces this agreement, and all parties must agree to the solution. You may need to sell some assets to repay creditors, but bankruptcy will reduce the total debt repayments required.
Bankruptcy hurts your credit for seven years after it is complete. Before deciding whether this solution will help you get out of debt faster, seek the advice of a licensed expert.
A consumer proposal is like a bankruptcy, but a licensee insolvency trustee negotiates directly with your creditors. The agreement reached is binding by both parties, but is not enforced by the courts. If you don’t pay the agreed settlement by a specific date, your creditors may continue collection efforts against you.
Some consumer proposal agencies will work on behalf of the creditors in these situations. Though they present themselves as reducing your debt as much as possible, the lender pays them based on how much debt they recover from you. Ensure you know how they receive payment to better understand whether they’re acting to your benefit or your creditors’.
A consumer proposal can harm your credit for two years after your proposal is complete. Yet, the benefits may outweigh the drawbacks of this solution. It is best to seek the advice of an expert before starting a consumer proposal.
Credit counsellors help guide you through the process of paying down your debts. They may act in a minor capacity to stop your creditors from charging interest on your outstanding financial obligations. Many of these services are non-profit organizations, yet some are very much for-profit and can charge high fees.
There are some minor benefits to credit counselling, such as having a personal coach in your corner. Ensure that they are acting in your favour and that their fees are reasonable to the level of service they provide.
An informal proposal is similar to a consumer proposal with one key difference. The insolvency trustee negotiating an informal proposal on your behalf is acting as your agent. The effect of this difference is that they receive compensation based on how much money they save you. Some informal proposals can reduce your debt to 30% - 70% of what you owe!
Effective Debt Repayment Strategies
If you’re going to pay your debts in full without consolidating them or negotiating with creditors, there are two effective debt repayment strategies that most financial experts recommend. Each strategy focuses on a specific debt while maintaining the smallest monthly payments on other debts. After paying off the debt you’re focusing on, you move on to paying off the next debt.
The Debt Snowball Method
The debt snowball method similarly pays off the debt that a snowball grows in size.
Choose the smallest debt you currently have. Each month, pay only the minimum payment on all other debts.
Focus as many extra savings towards paying off the smallest loan, credit card or line of credit balance as possible.
Once you pay the smallest debt off, move on to the next smallest debt. Continue working on this debt, maintaining the smallest monthly payment on other obligations.
Repeat this process until all your outstanding debt is gone.
The benefit of this solution is that you gain the satisfaction of eliminating a debt sooner than with other strategies. These small wins can motivate you to continue with the process and get out of debt faster.
The Debt Avalanche Method
The debt avalanche method is the most financially responsible method for paying off debt faster. This solution focuses on reducing the amount of interest you pay each month to enable you to put more savings towards debt repayment.
Choose the highest interest rate debt you currently have. Each month, pay only the minimum payment on all other debts.
Focus as many additional savings towards paying off the highest interest rate loan, credit card or line of credit as possible.
Once you pay off the highest interest rate debt, move on to the next highest interest rate loan. Keep paying the smallest monthly payment on all other debts.
Repeat this process until all your outstanding debt is gone.
The benefit of this solution is that you will pay less interest over time. Since you pay less interest over time, a more significant part of your savings goes to pay down the principal balance of your debts. This method is the most effective way to get out of debt faster.
Build Your Savings
Once you pay off debt, the next step is to begin building your savings. Keep using your new budgeting habits to ensure that you limit your spending. Try to save at least 10% - 20% of your income each month.
RRSPs are a great way to save money because they lock your money in, and you cannot take it out without risking a gigantic penalty. There are exceptions to this rule for first-time home buyers and continuing education. These accounts also present tax advantages that allow you to invest your savings more efficiently.
One of the best money-saving tips is to automate your savings each month. By automatically putting money away into an account each week, your savings will grow without needing to think about them. There are many great investment apps, such as Moka, which allow you to automate your savings.
Track Your Credit
Once your debt and savings are on track, it is paramount to take good care of your credit. The following five factors determine your credit rating:
Payment History 35% - Paying your bills on time is a crucial part of your credit score. If you miss even the minimum payment, your credit score can decrease a lot.
Utilization 30% - Utilization is the amount of balance you carry on your debts in relation to your limits. Credit balances of more than 30% of your limits lower your credit score.
Length of History 15% - The length of time you have established your accounts has a moderate impact on your credit. One important tip to improve your credit score is never close old accounts. The longer you establish your credit, the better your overall rating is.
Types of Credit 10% - The types of credit you have, or the diversification of the types of accounts, have a minor impact on your score. Ensuring you have access to multiple types of debt such as mortgages, car loans, credit cards and lines of credit helps increase your score.
Credit Checks 10% - Regularly applying for new loans can slowly decrease your credit rating over time. Only apply for credit when you need to. If you want to check your score, you can get your free credit score with this handy app from Mogo.
Now that you know how to get out of debt faster, it's time to begin putting your knowledge into practice. Start creating your budget and determining which debt repayment strategy works best for you. Once you make your decision, stick to it and track your monthly progress. Getting out of debt is challenging, but we hope that this guide helps you get out of debt faster.