Creating a Debt Management Plan
No matter how good your investment portfolio is, it will never be as important to your overall financial well being as the design and implementation of a debt management plan.
If an investor earns a 10 per cent annual return on their portfolio and everyone else earns eight per cent that year, they feel pretty darn good about themselves. But if that same person pays little or no attention to the various debts they owe and pays an extra four or five per cent of interest that was avoidable, the reality is that they may be far worse off at the end of the year overall.
While a debt free existence is a great goal, this shouldn’t necessarily be your top priority. Certain debts like high interest credit cards and other loans should be paid down as quickly as possible but other loans such as a low interest mortgage may not be a bad thing to keep in place. Each different type of debt you hold should be evaluated and a proper debt management plan should be put in place.
So how do you create a debt management plan? Here are a few ideas to get the ball rolling:
1) Become a better negotiator – You don’t need to automatically accept whatever interest rate you are offered. When negotiating a loan for a new car, a line of credit or a mortgage, take the time to find out what the best rates are at the moment for this type of debt and use your bargaining skills to get that same number.
2) Pay off the highest interest debt first – While this seems straightforward, many people still elect to pay an equal amount onto each of their debts owing. While this may feel like a good strategy, it will just keep you farther from reaching your goals. It is much better to pay the minimum only on all other debts and put the rest of the available free cash onto whichever account is charging the highest interest rate.
3) Set debt ceiling limits – The Canada Mortgage and Housing Corporation (CMHC) advises that your monthly housing costs, including mortgage, property taxes and utilities, should not exceed 32 per cent of your gross monthly income. They further recommend that your total monthly debt payments from all sources should not rise above 40 per cent. These are good figures to work off of and if a new purchase is going to put you above the 32 or 40 per cent mark, it may be a good time to reconsider.
4) Consider reaching a settlement – While not ideal, many people find themselves over their heads with a credit card debt or store financing program. If this debt continues to build up interest and there is no end in sight, it may be time to make a phone call and see what options there are. These creditors will often settle for less on the dollar so that they can guarantee they at least get some of the money back. If you can reach an agreement for a reduced, lump sum payment amount, you should also demand that the debt be shown as “paid in full” on your credit report.
5) Expect rates to go up – When considering taking on debt that will have a variable interest rate, or that will be around for more than a few years, it’s important to understand that interest rates can go up. Just because you can fit a $1,800/month mortgage payment into your budget now, doesn’t mean you will be able to afford the same debt when the rates have gone up in five years and it’s time for you to renew.
The above list of ideas is only a sample of the strategies you can and should use to deal with your debt. A proper debt management plan can be as simple or as complex as needed depending on your unique situation.
A Certified Financial Planner can be a great ally in this process as there are many different aspects to consider. In the meantime, hopefully the few tips above will at least get you started.