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Using debt to reduce debt

Slowly chipping away at high-interest debt can set you back further

Like many Canadians, Troy uses his credit card for routine purchases like gas, groceries and household items. Every month, he diligently pays the full amount owing on the due date because he knows too well that carrying a balance can be costly.

A little over a year ago, Troy was desperately trying to chip away at credit card debt but steadily falling further behind. “I had a few unexpected expenses come up so I put them on my credit card and, before I knew it, I was in over my head,” he explained. Troy was stretching to make the highest-possible payments, only to find a few weeks later that he was short on cash and charging more items. “I was stuck in a never-ending loop.”

Troy’s not alone in his struggle to manage debt. Credit cards offer convenient, interest-free credit if your payments are on time and cover the entire amount owing each month. Carry a balance, however, and you’ll find the amount you owe quickly increases. It’s because, on most credit cards, interest charges are added to your unpaid balance every day. In a nutshell, you’re paying interest on interest. Plus many credit cards will immediately charge interest on any new purchases if you have a balance owing. In this case, for example, if you make a payment on the due date that’s even $1 less than the balance, any subsequent credit card purchase would start attracting interest on the day you bought it, until the entire balance is paid. Any payments that don’t eliminate the balance are first applied to interest and fees, then to purchases. Policies may vary across credit cards but it’s easy to see how an unpaid balance can significantly increase the overall cost of purchases.

Consolidating debt in a low-interest loan

For Troy, the best way to get out from under his burden of high-interest debt was to refinance his mortgage. He qualified for a new mortgage to cover the total amount of his previous mortgage and credit card balances. Troy’s monthly mortgage payment increased but, once he eliminated the credit card debt, his overall monthly payments decreased. Essentially, he consolidated his debt in a low-interest loan. “It was such a relief,” he said. “It was an unbelievable feeling when I got that first statement with a zero balance!”

Troy also spoke with his Consultant about setting aside funds to pay for unexpected expenses. He contributes a small amount each month to a Tax-Free Savings Account (TFSA). Over time, he’ll accumulate enough to pay for things like house or car repairs when they come up. It’s an important step for Troy to avoid future debt problems.

Credit cards are a convenient and interest-free way to make purchases if you pay your entire balance each month when it’s due. Plus many credit cards offer purchase protection and other perks, such as a travel rewards. The key is to only charge items that you can pay for when the statement arrives.

If you’re strapped by high-interest debt, talk to us about low-interest options that suit your circumstances.

February 24, 2016

This column, written and published by Investors Group Financial Services Inc. (in Québec – a Financial Services Firm), and Investors Group Securities Inc. (in Québec, a firm in Financial Planning) presents general information only and is not a solicitation to buy or sell any investments. Contact your own advisor for specific advice about your circumstances. For more information on this topic please contact your Investors Group Consultant.