Friday, October 14, 2022 / by Mario Daniel Sconza
Financial Friday #131: Digging into the Details of your Debt
You don’t have to look at the news for very long before you see a headline about the debt problems of the average Canadian – and the numbers can be quite shocking!
• Average consumer (non-mortgage) debt: $21,000.
• Average household debt to disposable income: $1.82.
• Most indebted age group: 46 to 55 years ($36,241 non-mortgage).
• Average credit card debt: $5679.
The only positive has been that over the past couple of years, carrying debt (credit cards aside) in Canada has been pretty cheap. Anyone with access to home equity could have easily gone on a major spending spree at a pretty manageable cost of 2% to 3%.
Unfortunately, the consensus now is that those rates were once-in-a-lifetime bargains and aren’t likely to be repeated anytime soon. Interest rates have already risen sharply in 2022 and we are not through yet. It is widely expected they will be going up again with the next Bank of Canada announcement coming on October 26.
Despite our awareness that rates are rising, many people remain in the dark about just how much they are paying (or will soon be paying) to service their debts. Part of the reason for our nonchalance might be that we have all forgotten how interest (both simple and compound) can add up!
Car loans are a good example. The days of ultra-cheap financing have all but disappeared and according to Stats Canada the average car loan is now at 6.62%. While a lot of us can borrow at a lower rate depending on our credit score and the dealership, a 7-year loan on a $35,000 car at 5% is still going to cost you $6554 in interest charges. Shortening the term to 5 years (what used to be the norm for car loans!) will reduce that down to $4630.
Before you convince yourself a shiny new ride is well within reach by simply adding a couple of years to the financing term, make sure to rationalize the added interest cost, not just whether the bi-weekly payment is do-able.
Home equity backed lines of credit are another area where borrowing costs have increased dramatically and will very likely continue to rise. A quick Google search shows these rates are now hovering in the mid 5% range, about double what they were 2 years ago. We agree that not all debt is bad, and home equity is often a great option to pay down higher interest debts. However, it is no longer a source of super cheap cash for vacations, home renos, cars, furniture, etc.
If you are eyeing home equity to fund a $100,000 kitchen and bath renovation for example, make sure the accompanying $5500 in annual interest expense (assuming you pay interest only) is within your means. Also ensure you fully understand the terms and conditions for repayment and have a solid plan in place for repayment or refinancing. Don’t forget that interest rates are most likely going higher and home prices may continue to fall — a double whammy that could easily put your "equity-adding" renovation underwater very quickly!
A lot of people struggle with debt because they don’t really understand the details. Do yourself a favour and take the time to learn why paying the minimum on your credit card balance is futile and costing you a fortune, or how those fixed payments on your variable rate mortgage are fast becoming a huge liability as interest rates rise.