The Actual Cost of Carrying Debt

According to a recent survey 71% of Canadians carry some form of debt not including their mortgage.  In fact, the average consumer debt (credit cards, lines of credit, loans, etc.) is about $27000. 

Even more concerning; Statistics Canada reported that as of December 2013; Canadian household debt rose to 1.64.6% of disposable income.  This means that for every $1 of income earned, the average person owes $1.65 in debt – this is approximately at the same level as the Americans were at just prior to the U.S. housing bust.

The true cost of Debt

As shocking as these statistics may be, what’s worse it the actual cost of carrying all this debt.

From a financial planning perspective, the impact is quite substantial.  The average Canadian pays around $1400 in interest annually on his/her line of credit alone.  That may not seem like a lot however you must remember interest rates are at historic lows.  If the prime rate increases by only 1%, this annual amount goes up by $350. 

Missed Opportunity Cost

Another cost of this debt is the missed opportunity cost – meaning the money you spent in paying interest could have been used to fund your other financial goals. 

For example, pretend you’re 46 years old, and last year you paid $200 per month servicing your debt; this year; instead you used that money to contribute to your RRSP.  By the time you are 65, assuming an 8% rate of return, your savings would grow to $103,731.  But let’s back up and say you didn’t have that debt and you started contributing to you RSP a year earlier, you would have accumulated $114,532 by the age 65.  So, even though the debt only cost you $1200, the missed “opportunity cost” would be $10,801.

When Debt Makes Sense

Not all debt is bad; there are situations where taking on debt makes sense, particularly if that debt gives you an opportunity or investment that you wouldn’t have been able to take advantage of otherwise.

Education is the ultimate investment in yourself.  Not only is an advanced degree or certification an exceptionally long-lived asset (it lasts your whole life and never goes down in value), it will often have a direct and permanent impact on your earning power.

Maximizing your RRSP.  Borrowing to top up your unused contribution room can be a good idea – but make sure you use your refund to help pay off the loan.

Borrowing to Invest in Non-registered investments can help build your investment portfolio and generate some tax deductable interest cost.  However, the risk of this strategy largely depends on what you invest in, make sure the investments you choose match your risk profile.

Rental Real Estate is potentially another good use of debt, especially if the rental income can cover the mortgage and taxes.

When looking at your personal finances remember it is not just about the math; your emotions, psychology and behavior play a significant role in how you manage your money. 

If you are feeling trapped in a never ending cycle of bills, give me a call, we can restructure your debt, reduce your interest expense and free up those dollars to put towards your other financial goals.

Have a great weekend,

Tracey

 

Source:  Original article posted on Advisor.ca by staff 09-12-13