Making a plan to be debt-free

From: Financial Consumer Agency of Canada

Identify your debts

Start with identifying what you owe. Create a list of all your debts.

For each one, list:

  • the total amount you owe
  • the minimum monthly payment
  • the interest rate

Your list may include:

  • mortgages
  • car loans
  • credit card balances
  • line of credit balances
  • payday loans
  • taxes you owe
  • buy now, pay later balances
  • unpaid utility bills (cell phone, hydro, cable, etc.)
  • student loans
  • loans from friends and family
  • spousal support and/or child support you owe

Review your budget

A budget is a plan that helps you manage your money.

It will help you:

  • figure out how much money you get, spend and save
  • balance your income with your regular expenses
  • guide your spending to help you reach your financial goals

Use the Budget Calculator to find out where your money is going.

Decide on a strategy

Once you have created a list of all your current debts, begin your plan. The types of debt and the amount of debt you owe will affect your strategy for paying them off.

Choose a timeframe

Set a payment timeframe that is reasonable, yet still affordable.

If your timeframe is too long, you may lose focus due to a lack of progress. You'll also end up paying more money in interest.

If your timeframe is too short, you may not be able to keep up with your payments. You may start to feel it's unrealistic to continue.

Keep in mind, if interest rates rise, your monthly payments may increase.

Protect yourself if interest rates rise.

Decide which debts to pay off first

Depending on the type of debts you owe, it may be best to pay off certain debts first.

Debts with high interest rates

By paying off the debts with the highest interest first, you'll pay less interest. This will help you become debt-free sooner.

List your debts in order from the highest interest rate to the lowest. Make the minimum payments on all your debts. Then use any extra money to pay down the debt with the highest interest rate.

For example, payday loans often carry the highest interest rates of any debts you may owe, followed by credit cards.

Learn how payday loans work and what questions to ask a payday lender.

Find out about interest charges and minimum monthly payments when paying off your credit card.

Debts with the lowest balance

You may find it's easier to start with your debt with the lowest balance. You'll feel the accomplishment of paying off a debt sooner. This can keep you motivated to maintain your goal of becoming debt-free. However, this option may cost you more in interest over time.

Make a plan to pay back your family or friends

If you have a personal loan with family or friends, talk to them about the money you owe. Commit to a payment schedule that works for you and the person who lent you money.

You may want to consider writing post-dated cheques or setting up automatic money transfers in order to stick to the payment plan. This will also show that you're committed to repaying them.

Work directly with your creditors and your financial institution

Contact your creditors to discuss your financial situation with them directly. Your creditors are the companies you owe money to.

They may offer:

  • a lower interest rate on your debt
  • to extend your payments over a longer period of time and reduce your minimum monthly payment
  • to consolidate your debts into one loan

Get tips on how to contact and work with your creditors to help reduce your debt.

Close accounts on debts you have paid off

Once a debt is paid, consider closing that account. Only keep what you need and can manage responsibly. However, you should keep an older account open as your credit score is based partially on how long you have had credit, also known as your credit history. Closing all of your older credit accounts can make your credit history seem shorter than it actually is and can hurt your credit score. 

You may also want to consider using a secured credit card instead of a regular credit card. A secured credit card requires you to leave a deposit with the credit card issuer as a guarantee and you can only spend to that limit.

Learn how to use and apply for a secured credit card.

Consolidate your debts

You may consider applying for a loan or line of credit to pay off multiple debts with high interest rates. This is usually called consolidating your debts.

Consolidating your debts means you’ll only have to make one monthly payment rather than paying each of your debts individually.

A consolidation loan or line of credit may help you get out of debt if:

  • it has a lower interest rate than the debts you are consolidating
  • it has a lower monthly payment than all your other debts put together as you can put the extra money toward paying down your debt faster
  • you avoid taking on more debt with the available credit you free up

If you're considering a consolidation loan, make sure to ask your financial institution which type of debts you'll be able to pay off.

Be careful to not to use the credit that you have freed up with your consolidation loan. If you do then you will have even more debt than before.

Paying back a consolidation loan

Making the minimum payment on a consolidation loan will help you get out of debt eventually. However, the minimum payment on a line of credit will usually only cover the interest that you owe. You won’t get out of debt if you only pay this amount. Increase your payments if you can to help reduce your debt faster and pay less in interest.

A consolidation loan won't hurt your credit rating if you make your payments on time.

Eligibility for a consolidation loan

A financial institution doesn't have to provide you with a consolidation loan. To be eligible, you must have an acceptable credit score and enough income to make monthly payments.

Shop around for a consolidation loan

Be aware that some companies may offer consolidation loans with interest rates that are higher than the debts you are trying to consolidate. Make sure to shop around when you’re trying to consolidate your debt.

Different financial institutions may offer you different interest rates depending on the type of product you choose. For example, you may pay less interest on a line of credit than on a consolidation loan.

If you shop around for a consolidation loan, make sure you do so within a period of two weeks, so that it doesn't affect your credit score.

Find out what questions to ask before you take out a line of credit or a personal loan.

Read the terms and conditions of any contract before you sign it.

Avoid taking on more debt

Don't take on more debt. If you continue to spend more than your income, it will be difficult to become debt-free.

If you're considering borrowing more money, take a close look at how it would impact:

  • your existing debt payments
  • your budget
  • your ability to save for other goals

You're at risk of no longer being able to manage your debt if:

  • you're already having trouble making your debt payments
  • you're close to your credit limit and would have trouble making higher payments if interest rates increase

Tips to avoid taking on more debt

Follow these tips to lower your chance of taking on further debt.

Review your budget to reduce spending

Keep track of what you spend each month. Review your budget carefully to see where you can cut costs. Put needs before wants and look for expenses you can live without. By reducing your spending, you'll have more money available to repay your debts.

Reduce small, recurring expenses

Saving a little every day can go a long way.

Good examples of ways you can save money may include:

  • taking public transit instead of driving your car and paying for parking
  • bringing your lunch to work
  • making your coffee at home

Try the My Expenses Calculator to learn how small purchases can add up over time.

Keep your credit card in your wallet

To avoid getting into more debt, use cash or debit instead of your credit card. That way, you'll spend money you already have. Stop using your credit card until you have reached your debt repayment goal.

Avoid “buy now, pay later” offers

Some retailers, such as furniture stores, may offer you credit at 0% interest for a certain term. Remember to pay your balance in full by the time it is due. If you don't pay off the balance by this time, the fees and high interest rates that you will pay will add to your debt load.

Learn more about buy now, pay later plans.

Reduce your banking fees

Use ATMs from your own financial institution.

Review your banking package to know how many transactions are included.

Use the Account Comparison Tool to compare accounts and fees.

Look for ways to increase your income

Consider selling some of your assets or taking on additional work to make extra money to put towards your debt

Rebuild your credit

Going into debt may harm your credit score. A poor credit score can affect more than your ability to borrow. For instance, many employers require a good credit score in order to hire you. Landlords may also run a credit check before accepting you as a tenant.

You can improve your credit score by:

  • making sure you make payments on your debts and bills on time
  • not using all of the credit that is available to you
  • not applying for new credit if you don’t need it

Learn how to improve your credit score.

Know where to get help

If you're having trouble paying down your debt on your own, get help.

If you need help you can contact:

  • an accredited not-for-profit credit counsellor
  • a financial advisor
  • a Licensed Insolvency Trustee

They may suggest you explore other community and professional services first.

With their help, you'll be able to:

  • evaluate your current debt situation
  • determine your present and future needs
  • make a budget
  • find ways to pay off the debt

Before you sign up for services to get help to pay off your debt, it's important to explore your options and compare the different services offered.

Find a Licensed Insolvency Trustee near you.

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