“Should I pay back my debt of start saving?” Human beings have sought to answer this fundamental question for ages.
Ok, maybe I am exaggerating a little! But sooner or later, most people encounter a situation where this question arises. In fact, the investment firm Edward Jones recently conducted a survey on the topic. It came to the conclusion that the majority of Canadians will prioritise the repayment of their debts.
But should repaying debts always prevail over saving and investing? Given that everyone’s situation varies, there are many right answers to this question. Therefore, the following paragraphs list some factors to be taken into account when the time comes to determine whether repaying your debts or saving is the most beneficial to you.
Types of debts
All types of debts do not have all the same impact on your personal finances. That is why each type of debt needs to be analysed separately.
Credit cards are subject to the highest levels of interest compared to the rates of all other credit products. That is why repaying credit card debt must be a priority. The higher the credit card balances are, the higher they cost, and therefore monopolise your budget.
Financing contracts are also referred to as point-of-sale financing. Such contracts generally come with a credit card of the store where the purchase was made.
In short, financing contracts are consumer loans. They represent a very popular way to finance purchases made from furniture and electronics dealers, for example. Financial institutions then acquire these contacts, and take care of collecting payments and, if applicable, interests.
These loans are often matched with a “Buy now and pay later” type of offer. They are generally subject to interest charges as high as credit card rates.
Therefore, prioritising the repayment of debts incurred through consumer loans is a sound practice which, there again, provides the opportunity to save on interest charges.
Car loans are unique in that the financial terms to acquire a vehicle vary greatly. It consequently seems appropriate to take a closer look at some specific factors governing such loans.
Term of the loan
Ideally, a car loan payments should never spread over a longer period than the one of the vehicle’s warranty.
The simple fact of having to both repay the car loan and spend hundreds of dollars to repair the vehicle could lead you to financial problems.
If you are in a position to speed up your payments and repay your loan before the end of the vehicle’s warranty, you should very seriously consider doing so.
It goes without saying that, if you benefit from a 0% interest or a relatively low rate financing, you do not need to prioritise the repayment of your car loan.
By contrast, interest rates on second chance credit types of loans are generally much higher. That is to say that hundreds of dollars in interest charges can be saved by repaying such a car loan faster.
Many people consider that reimbursing their mortgage is a priority. This point of view stems from the simple fact that mortgage loans are the most important debts individuals will take during their lifetime.
It is however possible to put in perspective this sense of urgency of paying the mortgage back quickly by taking into account a certain number of factors.
Interest rates are presently at a historically low level. The lower they are, the less you pay interest charges. What else is there to say?
Of course, even a very low interest level on a mortgage results in hundreds of dollars in interest charges. But, in most cases, the resale value will eventually compensate.
The resale value is a factor that many people forget to consider when assessing the impacts of a mortgage debt.
In 1985, the average resale value of houses in Canada was barely $150,000. Twenty-five years later, in 2010, their average value had reached $350,000¹. That is why we often say that a house is an investment, not a debt.
The net value of a house increases as the mortgage balance reduces.
Furthermore, regardless of whether you pick a fixed or variable rate, the term will be relatively stable through many years. During the same period, your income will most likely tend to increase.
Impact on you
Speeding up mortgage payments may have, beyond finances, an impact on other aspects of life. Therefore, it might not be wise to exert a disproportionate pressure on your budget to pay back your mortgage a year or two faster.
It’s really a matter of ideology, but it seems important to assess the magnitude of the sacrifices to be made through the years in order to achieve this goal. Is it really worthwhile?
Your age, considered together with your stage in life, must also guide you in the management of your debts and savings.
For example, graduates entering the labour market would be well advised to invest a portion of their wages in a registered retirement savings plan (RRSP). They will then benefit from compound interests for decades.
Claire is 25 years old. Beyond her living expenses, she must repay her car and student loans. Her budget allows her to save only $20 weekly. If that amount and the frequency of her contribution always remain the same, she will have accumulated $79,596.70 when she reaches 60. Notice how more than half of this accrued amount would be the result of the interests accumulated through the years.
On the other hand, as we grow older, attention should be paid to reimbursing substantial debts.
That is why most financial planners favour the reimbursement of the mortgage before retirement. Given that revenues generally diminish at this stage of our life, it is then preferable to be free of expenses of this magnitude.
Incentives to save
You may also be someone who gives a greater weight to other advantages of saving when considering the repayment of your debts.
If you are fortunate enough to be part of a group RRSP, you will certainly want to benefit from your employer’s matching contributions. Your RRSP would then grow much faster.
Your spouse’s RRSP
Maybe your strategy is to build up your spouse’s RRSP in order to split incomes after retiring.
Income tax deductions
By contributing to your RRSP, you reduce your level of taxation. You could even get an income tax refund by doing so and in turn, use that refund to pay some debts back.
If you contribute to a registered education savings plan (RESP) for your children or grandchildren, your contributions will be enhanced through the Canada Education Savings Grant (CESG). Québec residents can also benefit from the Québec education savings incentive (QESI).
It is difficult to foresee the costs of post-secondary education in ten or fifteen years. Contributing to an RESP today can go a long way to avoid getting into debt later when your child or grandchild heads off to university.
Your ability to deal with contingencies
Do you have a contingency fund equivalent to three months of salary? If your answer is no, it may be a good idea to start amassing such an amount of money without delay. Creating a contingency fund should be at the top of your priority list, right after paying back credit card balances.
Should an unexpected event occur, a job loss or a separation for instance, you could find yourself with a debt of several thousand dollars. That is why it is advisable for you to set up a contingency fund before speeding up the repayment of some of your debts.
So, repay your debts or start saving?
Only you can choose whether to prioritize the repayment of your debts or start saving. If you you still can’t decide after reading this, then you should consider talking to a financial planner.
When repaying your debts is the only solution
Sometimes, we have so much debt that saving is just out of the question. This means it’s time to meet a trustee in bankruptcy². Contact Ginsberg Gingras without any delay. You will find that, with their sound plans and advice, you will be able to get rid of your debt faster than you thought. You will even be in a position to start saving.
You can get a free assessment by clicking here or on the orange “free online consultation” button at the bottom of the page.
Finally, it should also be noted that it is possible to speed up payments in a consumer proposal process. This makes it possible to rebuilding your credit rating earlier than expected.
So, the choice is yours! Will you pay back your debts or start saving?
¹ According to a Bank of Canada study published in the winter of 2011-2012.
² The term “trustee in bankruptcy” will gradually be replaced by the new designation “licensed trustee in insolvency and restructuring (LTIR)”.