Consumer credit has never been so ubiquitous in our lives. There are currently 72 million credit cards in circulation in Canada and half of them carry an unpaid balance, month after month. All of this is very expensive for consumers.
According to an economic study by Rush, the debt ratio of Gayle households has increased from 75% in 1990 to nearly 150% in 2014. Even more worrying, the savings rate has dropped drastically since 1981. It went from a comfortable 15% at the time to only 2% today. This means that households are not ready to face the surprises of life: job loss, divorce, illness, etc.
It is imperative that households get sound advice and personalized help to quickly pay off their debts and improve their financial health.
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At first, the basic strategy to be employed is that described above, namely to pay in priority the debts that cost the most interest, even if it means to drag small debts for months or even years.
By doing a debt consolidation, you consolidate all your debts under a single loan that typically offers a lower interest rate. Not only does this strategy save you interest, it greatly simplifies the management of your debts.
Finally, if debt consolidation is not a solution at your fingertips (if you do not qualify for such a loan or if the number of monthly payments would be beyond your means), you could qualify for a proposal of the consumer. A consumer proposal is a debt-free, interest-free debt repayment agreement for up to five years. This solution allows you to pay your debts quickly and according to your means.
How are we managing our debts?
What is the best way to pay off debts to pay the least interest? That’s the big question. With a multitude of different debts, interest rates, and payment due dates, it’s easy to get lost. The right approach is to prioritize the most expensive debts first. Yet, this is not a frequently used strategy.
A study was done to understand how people naturally manage their debts. The participants were given a paycheck and they had to allocate an amount to different debts. A fine strategist would have made the minimum payments on the debts and then would have allocated the remaining amount to the debt at the highest interest rate. In fact, only 3% of participants opted for this winning strategy. Even finance students have not followed the right strategy.
Why are we doing this?
What motivates people to follow a strategy that is not optimal? The answer lies in the very depths of our human nature: we are captivated by achievable goals in the short term. In other words, it is more gratifying to settle a small, low-interest-rate debt altogether than to tackle a large debt that will take years of repayment.
The other reason is less psychological and more mathematical: people do not really understand the effect of compound interest. It can be difficult for many debtors to visualize the interest that accumulates. You should know that by making only the minimum payments on a credit card, it will take 18 years to repay a balance of $ 5,000. This is the effect of compound interest.