Carrying a lot of debt can seem overwhelming. However, once you have a clear plan and start paying it down, bit by bit and month by month, you’ll see the difference in your statements. And you’ll feel the tide shift in your favour as you turn your focus to building up your savings.
There are different ways that you can leverage debt, and it’s not always “bad.” Let’s look at the various types of debt and how they impact your life.
Good debt vs. bad debt
Good debt is something that usually can help generate income and improve your net worth or improve the quality of your life. Things like education, your home or your own business can fall into this category. Two major types of good debt include mortgages and student loans.
Bad debt, on the other hand, is typically used for something that loses its value and is often costly, even if it has helped you buy something you love. Some common types of bad debt include excessive spending on clothing and furniture (beyond your means and what’s needed).
While you may enjoy the freedom and flexibility to do more in life by going into debt, be cautious. Watch for how much good debt vs. bad debt you have, and focus on increasing your net worth and future financial potential. Carrying too much bad debt can make it harder to qualify for more credit (including a mortgage) and reduce your ability to save for the long term.
Understanding different types of debt
Since a mortgage is a loan used to purchase a home, it will likely be the biggest form of debt you’ll ever have. Fortunately, the interest rate is typically very low compared to other forms of debt. And the result is owning a place you can call your own, which provides you and your family with not only a roof over your heads, but a sense of pride. You’ll also create equity that you may be able to access and leverage in the future.
Likewise, student loans help pay for post-secondary education, allowing you to focus on your studies—which can be costly. While student loans can become quite large and take many years to pay back in full, the education you receive can lead you down a fulfilling career path with a healthy income.
These forms of good debt can help improve your net worth over time. As you earn more income and your expenses decrease (paying down your mortgage, for example), this will leave more room in your wallet to put away for savings.
Credit card debt
Credit cards are extremely handy for day-to-day errands, online shopping, flights and hotels, along with major purchases such home renos and even your kid’s braces. However, it’s easy to accumulate credit card debt at the same time—just swipe or tap, and repeat.
Work out a budget and don’t go over because of the convenience of a credit card. In addition, ensure you’re making the minimum monthly payments and work out a plan to pay more where possible each month. Since many credit cards charge an annual interest rate of between 19.99% – 21.99%, those little charges can add up fast.
If you need to buy a vehicle, you likely don’t have cash on hand to make the purchase. Leasing is an option for new vehicles, but auto financing is a common route—whether you’re buying new or used. Whatever you drive home with, realize its value will decrease—and loan payments can steer your money away from savings for many years.
Lines of credit
A line of credit is a loan that can be accessed when needed. It typically has a lower interest rate than a credit card and can be used to make purchases (big or small), pay off other higher-interest debts or clear outstanding credit card balances. However, since it’s readily accessible, it can also be tempting to dip into and max out—increasing your interest payments and stretching you thin. Factor any interest payments into your monthly budget and your long-term financial planning.
Quick budgeting goes a long way
To relieve your debt burden, you need to find ways to pay it off faster. And that can start with a review of your accounts. Even if you only have a few minutes, get started and you’ll be off to the races.
First, create a very basic budget, which will show you how much extra money you have to work with each month. You can do this in a computer spreadsheet, on your smartphone or with a good old-fashioned paper and pencil.
Then, note how much you make every month after taxes and government deductions. Track what you’ve been spending your money on for the past three months and allocate how much goes towards various categories (for example, housing, transportation, food/groceries, entertainment, utilities, and saving/investing). If your expenses include debts, jot down details beside each, showing the payments required and the interest rate on each.
The difference between your income and expenses is how much you’ll have leftover each month. This money can be used for things such as investments, savings and paying down your debt.
Next, referring to your quick budget, review any unnecessary spending and make a plan to cut those costs where possible. In addition, you can set a target for how much money you can realistically allocate towards paying down your debt each month.
Two methods to pay off debt
There are two common strategies for paying down your debt—the debt snowball method and the debt avalanche method:
With the debt snowball method, you pay the debt with the smallest amount first. This gives you a sense of accomplishment as you pay off each one and can help provide momentum.
With the debt avalanche method, you pay the debt with the highest interest rate first. Once that’s paid off, you move on to the debt with the next highest interest rate and so on.
Either way, try to focus on paying off your bad debt first because it often has a higher interest rate. (This is where your initial budgeting and planning come into play, so you can easily see the rates and payments required on each debt.)
How to save: Even a little can go a long way
Having long-term debt can limit your ability to save, since your extra income is always going towards these extra payments. That’s why you should think about saving even while you’re paying off your debt.
When it comes to saving money, many people think they’ll just save what’s leftover in their bank account at the end of the month. But this strategy usually doesn’t work because there might be months when you have little to no money left.
One great way to get in the savings habit is to allocate some funds each month to go into your account. It’s often easiest to start off small and accelerate your savings over time.
For example, if you want to save 10% of your pre-tax salary (towards a new home purchase, education, retirement or whatever you dream), you’ll probably fail to reach this goal because it’s not a habit. Instead, start small, even only 2%, and increase the amount every month until you reach your 10% goal.
Try the 70-20-10 rule
Not sure how much money to budget for bills, savings or debt? Think of this “rule” more like a suggested starting point that you can modify to fit your needs.
Once you’ve deducted tax from your income, allocate 70% of your income towards your bills and expenses. Next, put 20% towards savings and investments. Then finally, you’ll have the remaining 10% towards paying down your debts or making charitable donations.
If you make $3,500 a month after tax, your budget would be:
$2,450 to cover your bills, housing and general expenses
$700 to save or invest
$350 towards debt (or donations)
Try it yourself! Are the results surprising? If so, it might be time to make adjustments.
You’ve got this
Debt can be both good and bad. Use good debt to improve your net worth and pay off any bad debt as quickly as possible. Once your debt is under control, you can start saving even more aggressively for your future. But since you’ve already put some money away, you’ve given yourself a great head start.
How Wyth Can Help
For short-term, accessible savings, open a Wyth Financial High Interest Savings Account (HISA) online in just minutes.
The content of this article is provided for general information purposes only and is not intended to be investment or legal advice. While this article provides tips for you to consider, it does not reflect the multitude of factors that can contribute to your individual situation. Seek counsel from your trusted professionals when making any investment, legal and financial decisions. While we strive to offer help, we accept no liability for any loss or damages arising out of your use or reliance of the information in this article, including liability towards third parties.