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Managing debt: Where should you start?

From credit cards to loans and mortgages, managing debt is a challenge many Canadians deal with on a daily basis. The good news is that it’s never too late to get a handle on these financial burdens to slowly get ourselves back in the black.

When it comes to tackling your debt you might find yourself wondering, where to start? This is totally normal! It’s easy to feel overwhelmed but with a few first steps, you can create a repayment plan that will set you on course to becoming debt free. 

The first step is to list all of your current debts. This includes not only your loans and credit card balances, but also your unpaid utility bills, phone bills or even a loan you took from your cousin’s neighbour’s colleague months ago. 

Having an overall picture of your debts ensures that you don’t forget any creditors when creating your debt repayment plan.

The next step is to determine your ability to repay your debts. To do this, you need to analyze your budget by listing all of your expenses, and whether they’re essential or discretionary. This will allow you to see how much you have left each month to pay off your debts comfortably.

Finally, prioritize one debt at a time, this way you can  focus all your efforts on eliminating them one by one. You should still continue to make your minimum payments on your other debts during this period so that they don’t affect your credit report.

This leads us to our next question…

Which debt should you prioritize first?

You should always prioritize the debt with the highest interest rate, since  they cost you the most. 

It’s important to know that your debt payment is broken down into two parts: one part of your payment is the interest payment, which goes to pay the interest fees, and the other is the capital payment, which pays the principal (the original amount borrowed). The higher your interest rate, the higher your interest payment will be, and the lower the capital payment to actually pay down the principal.

Note that the principal payment is your real payment toward your debt. So, when the interest portion of your debt payment is higher than the capital payment, it will take you longer to pay off your debt. That’s why higher-rate debt should be tackled first.

If you’re deciding between two debts with equal rates, choose the one with the smaller balance. Remember, paying off debt isn’t  a sprint, but a marathon. You need to break down your ultimate goal of paying off debt into smaller goals to keep the motivation you need to get through your plan. That’s why paying off your smallest balance first (when the rates are equal) will motivate you to keep going.

If you have multiple high-interest debts, it’s recommended that you use the Avalanche strategy to accelerate your debt payment. With this strategy, any time you pay off one of your high-interest debts in full, the freed-up money that would have been used for that debt payment is allocated to the payment of your next highest interest rate debt and so on. As you pay down each debt, the extra money will increase over time, which will help you get out of debt faster.