Debt often gets a bad rap, but not all debt is equal
Good vs. evil
If you are using credit out of convenience, to pay off other credit or to fund small purchases (entertainment, clothing, small household goods, vacations etc.), this can often be seen as bad debt and you need to use your credit wisely! It’s when you are using credit as a means of spending, rather than a means of improving your overall financial picture.
A story broke last week though that brought the concept of “bad debt” to a whole new level though. Canadians are expressing a preference to use their credit cards to pay their rent or condo fees. Yikes.
While there is value here from a convenience standpoint, as well as support for a common preference for an electronic lifestyle, this is potentially a recipe for debt disaster.
What is so “bad” about this type of debt?
Your shelter costs are considered a basic necessity, and it is essential to have the cash to cover it. It is a major component of your debt-to-income ratio, which is used to determine how much credit you can manage with your income.
Historically, cheques have been used to cover mortgages, rent, and fees, which served as a built-in way to keep you accountable – payments were linked directly to your bank account. When you remove the accountability of cash, you are effectively opening the gates to ramp up your debt load to potentially unmanageable levels. Add to this the fact that this is an ongoing monthly charge, rolled in with other credit purchases, and things could get out of hand fast.
Despite your best intentions to pay this particular charge every month, your financial circumstances could change. And then what?
“Credit is a tool, and it comes down to how you are using it to define whether it is ‘good’ or ‘bad’. Using credit strictly for convenience leads to “bad” debt all around,” says Jeff Schwartz, executive director of Consolidated Credit Counseling Services of Canada.
Schwartz adds, “It is wise to use cash wherever possible to avoid overspending. Not only does using cash make you more accountable for your spending, it has a finite supply. When it is gone, it’s gone, minimizing the chance of overspending and finding yourself under a mountain of debt.”
Why are you using credit?
“Good” debt often involves an investment, like mortgaging a house or a line of credit for home improvements which will ultimately increase the asset value of a house. Investment in education can be considered good debt as well, as in theory you are increasing your earning power by furthering your education.
Pay off that balance
For smaller purchases on your credit card, you still need to have the cash on hand to pay off the balance every month. Convenience use of credit is no longer convenient when you can’t pay for it comfortably, and simply making the minimum payments will snowball your debt to higher and higher levels. A credit card debt calculator can show you just how much time and money is lost when you fail to make bigger payments on your credit card. Paying the balance in full effectively gives you a zero per cent interest rate.
Anticipate the unexpected
Before you whip out the plastic, think ahead. What if something changed for you financially in the coming months? What if you experienced job loss or illness that might reduce or remove your income? Lighten your load to avoid debt disaster down the road.
If you have gathered up too much bad debt and you’re having a difficult time meeting your financial obligations, it might be time you reached out for some help. Call to speak to a trained credit counsellor and find out what your best options are. You can also try our free debt analysis online.