** Author’s note: While this article uses a Canadian example the same can be applied for the United States and other countries across the world as the principles of personal finance are the same regardless of the country. **
According to Statistics Canada the average personal debt to disposable income ratio in Canada was still at 150.6 per cent at the end of 2011. This means the average Canadian spends about $1.50 for every $1.00 they earn. Although this number represents a decline in the Canadian debt-to-income ratio from previous record-breaking quarters in 2011, this is still simply too much debt for Canadians to carry if they want to be in good financial standing.
So, short of getting another job to increase your income, the only real option you have to improve your financial outlook is to reduce the amount of debt you carry. Paying your debts back in-full on your own is the best option because it doesn’t damage your credit, but can you really create a successful strategy to pay back everything you owe?
Using national averages for the numbers, here’s an example of a strategy you can use to reduce debt effectively. As of the end of 2011, the average household debt in Canada was $25,960. Since 42 per cent of this debt load comes from credit cards, you can do an easy calculation to determine the average Canadian is currently holding about $10,900 in credit card debt alone.
To make the calculations easy, let’s assume you hold the total amount on one credit card with an 18 per cent interest rate. If the minimum payments are calculated using a standard formula of 2 per cent of your balance, it will take 50 years and 4 months to pay the debt off in-full if you pay only the minimum amount requested each month. This debt would end up costing you $31,097.80 in interest, so you effectively pay three times the amount of your debt in interest payments.
This is the problem with a minimum payment schedule, because it’s meant to maximize the amount of time you stay in debt so the credit card company can profit as much as possible from your interest payments. It may seem unfair, but it’s really just business. What’s more, there’s nothing preventing you from paying off the debt in a more strategic way that reduces your time in debt and total interest paid.
You do this by creating a fixed payment schedule on your credit card debts. This means you pay the same amount each month regardless of how low your minimum payment goes. It doesn’t have to be a large sum of money. Even if you can fix the payments you currently make now, you make a huge impact on your time spent in debt.
In the example above, the first monthly payment calculation for this debt would be $218. Assuming you pay your bill on time, this amount required decreases every month. However, if you commit to paying $218 every time, you will be out of debt in 7 years and 10 months. In addition, you only pay $9,398.37 in interest payments. You save yourself several decades in debt and over $21,000 in paid interest.
Of course, fixing your payments only works if you can commit to keeping your credit card debt load where it is now. You have to commit to stop using credit before any debt reduction strategy can really work to your best advantage. In addition, if you’re already struggling to make the minimum required payments on your debts, you may not be able to fix the payment schedule without putting other areas of your finances at risk. In this case, it’s advisable to seek help and find a way to make the payments on your debts more manageable within the limitations of your finances.
Connie Solidad has been writing about finances and debt consolidation for years. She’s an expert in the industry and writes about debt consolidation topics and credit counseling options and resources. When Connie is not working, she loves playing with her two dogs in Tampa, Florida. To learn more about debt management refer to ConsolidatedCredit.ca.
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