How to tell if you’re over-using credit—and get it under control

According to the latest report from Statistics Canada, the average Canadian owes more than $23,000 of non-mortgage debt. Even our seniors (those 65-plus) are taking debt into retirement and owe on average $16,000 of non-mortgage debt. The reality is that we’ve become comfortable carrying debt and making minimum payments on our credit cards, lines of credit and other forms of credit. Often, we don’t realize how dependent we are on credit until we reach our credit limits—and then discover how hard it is to manage our expenses without relying on credit. 

One of the best ways to determine if you’re at risk of future financial problems is to put your credit cards away; go cold turkey and stop using credit for three months. Why three months versus one month? It’s because you can mask your financial situation for one month by cleaning out your freezer or pantry, and curbing your lifestyle to get by. It’s a lot harder to do for three months in a row. If you want to try this self-test, you can choose to pay in cash or with your debit card; either is fine to use providing you are keeping track of your expenses.

You can make this test even more realistic by taking into account your total costs for irregular, seasonal and one-time expenses that come up during the entire year. These include things like car repairs and maintenance, clothing, vacation and annual insurance premiums. It may be that one or more of these expenses do not come up during your three-month test period, but you need to account for them in order to know for sure whether you really can cover all of your living expenses without leaning on credit. may Once you’ve added up these expenses, divide the total by 12 and set this amount of your income aside each month in a separate account. The example in the table below outlines how to do this.

The person in the example above would set aside $500 each month in a separate account and use these funds to pay for their seasonal, irregular and one-time annual expenses.

Now, can you meet all of your living expenses, debt payments and set funds aside each month for your annual, seasonal and irregular expenses without using credit for the next three months you’re doing okay financially. If you’re finding it difficult to pay your bills on time and running out of money between paydays without using credit, it’s in your best interest to look at different options to regain control of your finances and get out of debt—but understand that it takes time to get into debt, and so it will take time to get out of debt. You have to take a realistic approach when looking at different debt solutions. With this in mind, here are a few to consider:

Debt consolidation

While you can’t borrow your way out of debt, depending on the amount of debt that you owe, your credit rating and overall financial picture, you may be able to consolidate your debt through your financial institution at a lower overall interest rate and monthly payment amount than you are currently paying. I recommend taking out a loan versus a line of credit or home equity line of credit since a loan has a set monthly payment and a fixed date when the loan will be paid in full. With a line of credit, the minimum monthly payment drops as the balance decreases, which means you will need to be disciplined and maintain your original payment—otherwise, it will take a longer period of time to repay it in full and you’ll end up paying more interest. It can also be tempting to use your line of credit for other purposes once you’ve repaid your original debt, and find yourself back in the red once again.

Liquidating assets

If you have savings on hand, it makes sense to use that money to pay down or pay off your debt, especially if you have a high-interest loan and credit card debt. I would caution you not to deplete your savings entirely, as it is important to have the equivalent of three months of expenses set aside in a savings account* for emergencies. (Some people say they simply have a line of credit for emergencies, but if there’s a chance you’ll be tempted to dip into that “emergency” source of funds, risking your access to the money when a true emergency crops up, it’s best to avoid.) 

Credit counsellors are often asked if it is a good idea to liquidate funds in a registered retirement savings plan (RRSP) to pay off debt. Our perspective is that retirement savings are meant for retirement and need time to grow and provide you with a future retirement income. Your future self will thank you for not cashing them in. Funds withdrawn from an RRSP* are taxed at source, which means you will need to withdraw 30% more than what you owe to cover off the tax requirement. Funds within a tax free savings account (TFSA*) would be a better alternative for paying down debt, as they are not taxed when withdrawn. Before considering this option, you will need to validate that any funds in your TFSA invested in bond or equity funds have not declined, as it would not be a good decision to “cash out” when your funds may be at a lower value than when they were purchased.