Managing different kinds of debt

Did you know that there are many different kinds of debt and that in order to manage your debt load successfully, you should understand how they work in order to deal with debt responsibly?

“One of the most important tools that you can have in order to responsibly manage your debt and reach your financial goals is financial literacy. Understanding these fundamentals will help you stay out of debt trouble. If you don’t take the time to understand what your obligations are and how to budget accordingly could mean debt problems,” says Jeff Schwartz, executive director, Consolidated Credit Counseling Services of Canada.

Have you taken on more debt than you can handle and now you are in over your head? Our trained credit counsellors can help you to review your debt load and determine what your best options are to become debt-free. Call us at or get started with our free online debt analysis .

Here are some key credit terms and types as well as tips on how o manage the most common types of debt in Canada.

Installment debt vs. revolving credit

Installment debt

With installment debt, you take out a set sum of money that has an amortization (the total length of the loan) and a term (the length of time that the interest rate is good for). Your payments will be fixed for the term of the loan.

Some of the most common installment debt products that you’ll see are personal loans for cars, RRSPs, consolidation loans, student loans or other larger household items. As you make payments, the loan will reduce until it is gone. Generally speaking, the same amount of principal and interest is applied every month against the loan.

A mortgage loan is technically considered installment debt but has different rules than regular personal loans.

“One of the benefits of installment debt is that you can budget for it more easily because your payments are fixed. Another benefit is that by having installment credit, alongside your credit card, can help to increase your credit score as long as payments are made on time because it shows that you can handle diverse types of credit,” says Schwartz.

Installment debt can be secured or unsecured. Typically, secured loans have lower interest rates and can be for larger amounts of money. Unsecured loans, because they are seen as a greater risk by the financial institution, have higher interest rates and are for less money.

Installment loans usually need a letter or note of direction for the proceeds. You can’t typically take out a personal loan for a fixed amount and let the money sit in your bank account. It has to have a purpose that you can show i.e. debt consolidation.

Revolving credit

Revolving credit is also known as open credit. You’ll be familiar with open credit with your credit card or your line of credit. You are given a set balance by the creditor. You are free to use and re-use your revolving credit as many times as you’d like, within the balance.

Your payments will vary from month to month, depending on the balance that you are carrying. You are responsible for a minimum payment of the balance (usually 5 percent, but that varies as well). It is important to note that this minimum payment is quite different than the payment that you make with an installment loan. Much of the revolving credit minimum payment goes towards interest, and only a little bit goes towards reducing your principal debt. That’s why it takes so long to reduce your debt load if you are only making the minimum payment.

The interest rate that you are charged is based on the prime rate set by the Bank of Canada, which means that this kind of debt is more vulnerable to fluctuations in interest rates. It can be harder to budget for variable payments.

Some of the pros of revolving credit are that it is convenient. It’s also easier to use if you don’t know the exact amount that you need to finance (i.e. if you are doing home renovations).

For all of its convenience, when revolving credit isn’t properly managed, you can create all kinds of debt problems for yourself. It’s easier to spend beyond your means. If you end up charging more than you can pay off in a month, you will incur extra costs with interest. Interest will continue to accumulate until it is paid off in full, which means your original purchase will balloon in price.

Auto loans

One of the most common installment loan products is an auto loan. In the last several years, car dealers have extended car loans over long amortizations in order to make payments more affordable on a monthly basis and to encourage consumers to “buy more car”.

In order to manage this kind of debt responsibly, remember that cars are depreciating assets. As you are making payments down on your car, its value will decrease. If you extend the car loan over too long a period, you can easily end up owing more than it’s worth.

Never extend car payments over more than about 48 months. If you can’t afford the payments with that amortization, buy a cheaper car.

Credit card debt

Keep your credit card debt under control by only using credit cards to cover expenses that are covered within your budget. Make a point of making payments on time every month and only charge what you know that you’ll be able to pay off in that time frame.

Student loan debt

Taking out student loans is the reality for many students because of the high price of education. However, financial institutions will often offer students more money than they really need. It can be tempting to take all of this money out “just in case”. However, you need to remember that all the money that you take out needs to be paid back.

Reduce the overall amount of debt that you need by working part-time during school, or deferring school for a year or two while you accumulate your savings.

Debt doesn’t have to be a problem. Learn about how to manage your debt today to achieve your financial goals tomorrow. Call one of our trained credit counsellors at or visit our free online debt analysis .

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