Dealing with Debt
The adage “all things in moderation” applies to many aspects of life—and debt is certainly one of them. Gaining control of your debt and paying it down can have a positive impact on your ability to obtain affordable loans with lower interest rates.
While it appears Canada’s average consumer total debt is stabilizing, TransUnion reminds consumers that regardless of your total amount of debt, there is always room for work.
“Regardless of your debt amount, lowering the amount of debt you carry can lead to potentially healthier credit, reduced loan rates and savings on interest payments,” says Tom Reid, director of consumer solutions for TransUnion.ca.
In TransUnion’s most recent quarterly analysis of Canadian credit trends, TransUnion found that the average consumer’s total debt (excluding mortgage) dropped to $25,594 in the third quarter of 2011, marking the third consecutive quarter the variable has either declined or remained stable. Canada had previously experienced 26 straight quarterly increases in average consumer debt between 2Q 2004 and 4Q 2010.
So is there a correlation between the amount of debt you currently carry and the interest rates and credit or loans you are able to obtain? Absolutely; here is how:
Although your credit report does not contain your income information, you can calculate your debt –to-income ratio by comparing the difference between your monthly income earned against the debts and payments in your credit report. Lower debt-to-income ratios are better because lenders view borrowers with low debt-to-income ratios as potentially having a better capacity to repay their debts.
Lenders typically view debt-to-income ratios less than 20 per cent as very good, 21-39 per cent as good, 40 to 55 per cent as fair, and ratios greater than 55 per cent as poor.
A low debt-to-income ratio along with a good credit standing, the latter of which is largely determined by timely payments, are both considered very favorable by lenders. Most often, a low debt ratio along with a good credit standing can entitle you to receive better interest rates and in some cases provide less collateral.
It is important to keep in mind that individual or household capacity for debt can vary significantly. Your lifestyle or stage in life can dramatically influence your ability to carry debt. Based on your current debt ratio, you may be able to save part of your income each month. If your discretionary spending makes it difficult for you to save each month, you might consider reducing it in order to increase your monthly savings. This may make it easier to repay any additional debt, if needed.
Remember that your debt-to-income ratio is not the only criteria that may be used by lenders to evaluate your creditworthiness. Additional factors include your credit score, and in some instances, any collateral you have to offer to reduce the lender’s risk in case of default. These and other personal factors are evaluated according to each lender’s policies and preferences.
TransUnion offers consumers a free debt analysis worksheet on TransUnion.ca—as well as recommends the following tips to consumers to help them pay down their debt:
1.Get the facts Collect all your account, loan and credit information and carefully go over the records. Write down the monthly payment, debt amount, interest rate and term of each debt on a sheet of paper. Next, write down your total monthly income and list your estimated monthly expenses. Order your credit report and credit score online to get a baseline for tracking your improvements.
2. Do the math Calculate your monthly budget and find a way to reduce your expenses so that you are saving 10 per cent of your income each month. Apply these savings toward paying off your debts.
3. Negotiate While you are working on reducing those balances, try lowering the interest rates on some of the highest interest debts. Call your creditors and try to negotiate for a rate reduction.
Also, take this opportunity to see if you have any account balances above 50 per cent of the available line of credit. Having high balances can harm your credit score; assuming the interest rates are comparable, consider transferring part of a high balance debt to another account, or try to pay down the high balance debts faster.
4. Refinance After taking control of your credit card and small loan debts, take a look at your major loans. Would it make sense to refinance your mortgage or auto loan? Reducing your interest rate by a few points can potentially save you hundreds each month. Talk with your lender about a home equity loan; you can use the money from the home equity loan toward reducing your high interest debts.
5. Stick to the plan Create a payment calendar with the due dates and the payment amounts you just calculated. Sign up for automatic bill payment through your bank or register for online payments to keep you on schedule. Track improvements in your credit profile by registering for credit monitoring from a site like www.TransUnion.ca. With this service you will receive quarterly updates, email fraud alerts, fraud resolution assistance and trending reports that highlight your financial changes over time. Set goals for reducing your debts and don’t forget to celebrate when you reach a major debt reduction milestone!
Worried about falling into too much debt? TransUnion provides three simple tips for consumers to help them avoid racking up too much debt:
1. Set a Budget and Stick to It
Make a list of all your monthly expenses. Be thorough. Once you subtract your fixed monthly expenses from your monthly income, apply about 10 per cent to paying down any outstanding debts and also set aside money that can be used in case of an emergency. This will allow you to use saved money if the unexpected happens instead of having to take on more debt. Once you have created the budget and saved, look at what money you have left and spend accordingly. Make sure to track all your purchases so as not to go over your monthly budget.
2. Buy What You Need It’s easy to buy things we actually don’t need or very rarely use. Before buying an item, try to evaluate its usefulness to yourself; give it a mark out of 10. If you give items an honest score, you will think twice before spending excessive amounts on basic items or on items you don’t need. If you’re an impulsive buyer, try waiting a day before buying something. If you really want and need it you can come back the next day.
3.Track What You Spend It is easy to forget how much we spend. When we use credit cards, it is easy for us to forget how quickly the money can be spent. For example, you stop for coffee and a muffin each morning on your way to work. At $5 a day, that is $25 a week, $125 a month, and $1,500 a year. Would you be willing to set aside $1,500 at the start of year just for coffee and pastries? Not likely.
Tom Reid is director, Consumer Solutions with TransUnion.ca where his primary responsibility is building and delivering a suite of solutions that provide Canadians with online services and educational resources. For more information about the educational resources and services available to individuals, go to www.transunion.ca.