Managing debt: How to get out of debt

The problem with debt

Most Canadians carry at least some debt whether it’s a student loan, a credit card balance, a vehicle loan, or a mortgage. However, having too much debt can:

• Reduce your flexibility to achieve important financial goals in your life
• Create stress and anxiety in your life and relationships
• Impact your credit score and your ability to borrow money in the future

It’s important to recognize that not all debt is bad. Some types of debt can help you reach financial goals, while others can set you back.

Budgeting your way out of debt

The first step to managing your debt is to create a budget that helps you live within your means and gives you an accurate understanding of your income and expenses.

Assess your current financial situation

• Gather all your financial statements.
• Calculate your total monthly income.
• Add up all your debts and determine a minimum monthly payment for each one.
• Calculate the amount of interest you’re paying each month based on the minimum payment and how much additional money that will cost you over the long term.

Identify essential and non-essential expenses

• Determine expenses you need to live and whether there are ways to reduce their cost (rent, groceries, mortgage, insurance, utilities, etc.)
• Identify expenses can you reduce or do without (such as dining out, entertainment, luxury items, subscriptions, etc.)

Allocate money to debt repayment

• Calculate how much money from cutting back or saving on expenses you can put towards paying down debt.
• Start small and set realistic goals to pay off debts.
• Tackle higher interest debt first.

Monitor your spending

• Stick to your reduced spending plan.
• If necessary, ask a trusted friend or family member to regularly hold you accountable to sticking to your plan and getting out of debt.

Common debt repayment methods

There are 2 methods you can consider for repaying your debt, depending on your financial situation.

Avalanche method

• Prioritizes paying down the highest interest debt first while making minimum payments on other debts
• Once highest interest debt is paid off, add that payment to the next highest interest debt, and so on

Here’s an example of how the Avalanche method would work if you had these debts:

• A credit card with a $4,000 balance, $175 minimum payment and 18% interest rate
• A second credit card with an $800 balance, $40 minimum payment and 13% interest rate
• A vehicle loan with a $3,500 balance, $120 minimum payment and 7% interest rate
• A student loan with a $10,000 balance, $200 minimum payment and 5% interest rate

You’d pay off the first credit card as quickly as possible, adding $50 a month to your minimum payment of $175 for a total of $225, while still paying the minimum payments on your other debts.

Once the first credit card is paid off, you’ll add the $225 to the $40 minimum payment (total $265) for the second credit card until it’s paid off.

Once the credit cards are both paid off, add the $265 to the minimum payment of $120 for the vehicle loan (total $385) until it’s paid off.

Then once the vehicle loan is paid off, add the $385 to the $200 student loan minimum payment (total $585) until you’re out of debt.

The above example is for illustrative purposes only.  Situations will vary according to specific circumstances.

Snowball method

• Tackle the smallest payments first, then work your way up to the largest payments as debts are paid off

Here’s an example of how the Snowball method would work if you had these debts:

• A credit card with an $800 balance, $40 minimum payment and 13% interest rate
• A vehicle loan with a $3,500 balance, $120 minimum payment and 7% interest rate
• A second credit card with a $4,000 balance, $175 minimum payment and 18% interest rate
• A student loan with a $10,000 balance, $200 minimum payment and 5% interest rate

You’d pay off the first credit card as quickly as possible, adding $40 a month to your minimum payment of $40 for a total of $80, while still paying the minimum payments on your other debts.

Once the first credit card is paid off, you’ll add the $80 to the $120 minimum payment (total $200) for the vehicle loan until it’s paid off.

Once the vehicle loan is paid off, add the $200 to the minimum payment of $175 for the second credit card (total $375) until it’s paid off.

Then once the second credit card is paid off, add the $375 to the $200 student loan minimum payment (total $575) until you’re out of debt.

If you’re uncertain which method would get you out of debt faster, this debt calculator can help.

The above example is for illustrative purposes only.  Situations will vary according to specific circumstances..

Debt relief programs in Canada

If you need help to pay down debt, it’s important to know where you can get it.

Debt consolidation

A lending specialist can work with you to combine multiple debts into 1 new loan with a lower interest rate. This can make managing your debt repayment easier and reduce your interest costs.

Credit counselling

Organizations such as the Credit Counselling Society and Credit Counselling Services of Atlantic Canada offer education, resources and plans to help you manage your expenses, pay off debt and set financial goals. If your workplace benefits are through Canada Life, you or your family members may also qualify to have some credit counselling fees covered by your plan.

Consumer proposal

This is a formal, legally binding process administered by a licensed insolvency trustee (LIT) who’ll work with you to develop a "proposal". This is an offer to pay creditors a percentage of what you owe them and/or lengthen the time you have to pay down the debts. The term of a consumer proposal can’t exceed 5 years.

Payments are made through the LIT who uses that money to pay each of your creditors.

A consumer proposal is 1 way to avoid declaring bankruptcy.

Using a debt settlement company

Debt settlement companies are for-profit businesses that negotiate with creditors and offer them an amount of money to eliminate your debt. This amount is often lower than your total debt. If your creditors agree to the offer, you must pay your debt settlement company. The debt settlement company will then pay your creditors.

Filing for bankruptcy

Bankruptcy is considered to be the last resort for dealing with debt.

If you choose bankruptcy, you’ll work with an LIT to complete the required forms and file them with the Office of the Superintendent of Bankruptcy (OSB). Then, you’ll be formally declared bankrupt.

Increasing your income to eliminate debt

Another strategy to pay down debt is to increase your income. Think about:

• Freelancing or consulting in addition to your regular employment if your employer allows it.
• Monetize a hobby or interest into a side-hustle (craftmaking, a YouTube channel, selling goods online, etc.)
• Advancing your career  through a promotion,  education, or negotiating a higher salary.
• Income producing investments such as real estate.

Statute of limitations on debt in Canada

While unpaid debt isn’t likely to expires or just disappear, in Canada, there’s a statute of limitations or law that provides a specific timeframe during which a collection agency can sue you in court to collect your debt. This timeframe varies from 2 to 6 years depending on the province or territory in which you live.

Ways to avoid debt

Consider these tactics to keep from falling further in debt:

• Pay for things with cash instead of credit.
• Build an emergency fund.
• Separate “needs” from “wants” to avoid impulse buying and buy-now/pay-later purchase.
• Close previous credit account so you’re not tempted to reuse them. 
• Give credit cards to a family member for safekeeping so you can’t use them.