Buying on credit and taking out loans have become commonplace, but consumers who spend beyond their means can end up with an unmanageable debt load and flush their money straight down the toilet. 
As it relates to getting a mortgage, debt can hit you three ways, making the prospect of getting a mortgage seem impossible. Here's why:
- Money toward the interest component of debt repayment takes away from your ability to save for a down payment.
- Any debt repayment difficulties and you risk harming your valuable credit rating, which can take years to repair.
- The Government of Canada through mortgage lenders inforces how much monthly debt payments you can have relative to your income. Too much consumer (bad) debt reduces the headroom you have to take on additional (good) debt to buy a house, either limiting what you can borrow or shutting you out of the real estate market completely.
Dealing with debt can often seem like an impossible task.
When you decide to tackle your debt, it is important to have a plan that will work for you. If going into debt has harmed your credit rating, you also need to take action to rebuild your credit. A poor credit rating will affect your ability to qualify for a mortgage to buy your own home.
The task before you is simple, though perhaps not easy. There are two parts:
- Resolve and Create a Plan to be Debt-Free: Analyze your debt situation and consider ways to get out of debt
- Rebuild your Credit: Focus on using credit responsibly and building a good credit history and score.
Your Plan To Be Debt-Free
Deciding to tackle your debt can seem overwhelming. The first step is to make the decision to be debt-free; the next step is to identify a plan to get there.
List your debts: the reality check
Create a list of all your debts. As scary as this step may seem, it is important to realize the total amount you owe. For each debt, list the total amount owing, the minimum monthly payment and the interest rate. Your list could include:
mortgage(s)- credit card balance(s)
- cash advances
- line of credit balance(s)
- payday loans
- taxes owed
- buy-now-and–pay-later balance(s)
- unpaid bills (cell phone, hydro, etc)
- personal loans such as car loans
- student loans
- loans from friends and family
- alimony and/or child support owing.
How much is your debt costing you?
Part of managing your debt is understanding how you got there. When you made a purchase in the past, did you consider the total cost of the item? If you could not pay for the purchase in cash and needed to borrow money, the total cost was probably higher than the sticker price.
Example
You bought a $2000 big-screen TV on credit with an interest rate of 18%. In scenario 1, you had a set monthly payment of $40. In scenario 2, your set monthly payment was $100.
| |
Scenario 1: Set monthly payment of $40/month |
Scenario 2: Set monthly payment of $100/month |
Scenario 3: Paid off in full when the bill came. |
| Original balance |
$2,000.00 |
$2,000.00 |
$2,000.00 |
| Interest paid |
$1,724.47 |
$395.65 |
$0.00 |
| True cost |
$3,724.47 |
$2,395.65 |
$2,000.00 |
| Time to pay it off |
7 years and 10 months |
2 years |
0 days |
| Interest Savings |
|
$1328.82 |
$1,724.47 |
| Reduced time to pay in full |
|
5 years and 10 months |
7 years and 10 months |
Ideally, consumers should save in advance for large purchases as illustrated in scenario 3. By having the money to pay for the item in full at the time of purchase or to pay off your credit card balance in full before the statement due date:
- you would not be taking on consumer debt;
- you would not have to pay any interest; and
- you would not have the burden of monthly debt payments.
It is also important to understand how much of each payment goes to the principal of the loan and how much goes to interest.
In scenario 1, the majority of your payments went toward the interest, and not the principal, for almost four years of the payback period.
However, in scenario 2, more than 70% of your payments went toward the principal from the beginning of the loan. This is why you paid off the balance so much faster in the second scenario.
To figure out how long it will take you to pay off your credit card balance, try FCAC’s Credit Card Payment Calculator Tool. This tool shows you how long it would take you to pay off your credit card balance if you only made the minimum payments, as well as options to pay off your credit card faster and pay less interest.
Decide on a strategy
The types of debt you have and the amount of that debt will affect the strategy you choose to try to pay it off. You may choose to tackle your debt by yourself, or get help by using a third party, such as a reputable credit counsellor. No matter what strategy you choose, make sure the plan is achievable and realistic. Learn more about getting out of debt strategies.
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