There has been a lot of news from the daily newspapers and the Canadian government over the past year about excessive debt levels for consumers. For example take a look at these statements from Statistics Canada from mid September:
Canadian household debt continued to rise in the second quarter as individuals took out more mortgages at historically low rates and obtained consumer loans, Statistics Canada said on Tuesday.
Policy makers have warned Canadians against taking on too much debt, especially as interest rates can only go up over time and some may find themselves unable to afford their debt payments.
The Bank of Canada warned earlier this year that the number of Canadians who were vulnerable to an adverse economic shock had risen to its highest level in nine years.
Despite an increase in home prices, household net worth declined 0.3% in the second quarter, Statscan said, because of a drop in prices of shares held by households, including pension assets.
Per capita household net worth fell for the first time in a year to $184,300 from $185,500 in the first quarter.
These statements show that the Canadian government is concerned about how much debt the average consumer is taking on including their mortgage. What does this warning from the government mean to you as a new buyer or if you are trying to refinance your mortgage? What does this warning mean to you if you are not refinancing or buying a new property? What exactly should you be doing about high consumer debt levels on a personal basis?
The average consumer carries many credit cards with various rates. Which cards should you focus on paying out first – The card with the highest balance, or the card with the highest interest rate? I did a study based on some commonly available credit card rates and came to some interesting conclusions!
Take the chart example below:
| Card Type |
Air miles bank credit card |
Unsecured line of credit |
| Rate |
19.99% |
6.5% |
| Balance on Card |
$21000 |
$20000 |
| Minimum Payment |
$443 |
$593 |
| Interest portion of the minimum payment |
$319.49 |
$106.47 |
You can see that on the high rate credit card, most of the minimum payment goes toward paying interest and very little towards paying principal. Conversely, if you compare the lower rate card, your minimum payment pays less interest and more principal. You can see from the chart above that the high rate card is going to be very difficult to pay off without increasing minimum payment. The unsecured credit line however, is going to be paid off much faster without increasing the minimum payment. Which card should receive more than the minimum payment – the higher rate card.
In fact, as you pay down the high rate card the minimum monthly payment will drop. Do not be fooled!! Keep paying as much as you can because remember – if you start paying the minimum payment on your higher rate interest cards, the outstanding principal never goes away.
Should you transfer high interest rate card balances to lower rate cards? I get this question from many clients and I would have to say – maybe. I might transfer balances if I had a lot of room on lower rate cards but if you remember from several issues back – we discussed what happens to your credit report when several of your credit cards are maxed out and some are at zero balances. Your credit bureau likes to see an even balance (percentage wise based on available credit) across all consumer credit products. Therefore, it does stand to reason that you should not really be moving around credit card balances and maxing out low rate cards.
I would probably leave the balances as they are unless I could transfer a full amount of 1 high rate credit rate to a low rate card and not max out the low rate card.
Here is another real world example on how expensive it can be to carry high rate credit cards.
| Card Type |
Air miles bank credit card |
Secured line of credit |
| Rate |
19.99% |
4.00% |
| Balance on Card |
$21000 |
$94722 |
| Minimum Payment |
$443 |
$311.27 |
| Amount of payment that goes toward interest |
$319.49 |
$0 |
This example shows that the low rate card could service almost 5 times what the high rate card could service – both cards were paying approximately the same amount of interest. Even though no payments were made towards principal on the low rate card, it would still be more cost effective to make larger payments towards the smaller debt of $21000. Once the small debt was cleared, the same amount of cash flow could be concentrated on the larger debt.
As a parting note, take care when paying your bills to ensure that the money you are paying to credit cards makes sense. Use store credit cards and other high rate cards sparingly.
Toronto house sales are slowing, but economists are not predicting a crash in the real-estate market.
