The Burden Of Debt
An RBC survey showed that average non-mortgage debt has increased again this past year by an average of 21% or almost $2,800 for a total consumer debt load of nearly $16,000.
Some reasons are given, such as lagging job growth and incomes only rising moderately, but the actuality is that people are still spending beyond their means!
Related: What’s busting your budget?
Very few people earn enough to pay cash for life’s important purchases – home, car, university education – which makes debt unavoidable, but attitudes have to change.
Good debt vs bad debt
Any discussion about debt will revolve around whether it is good debt or bad debt.
Good debt – an investment that will grow in value or generate long-term income, e.g. mortgage, student loan, business loan.
Bad debt – used to purchase things that quickly lose their value and carries a high interest rate, e.g. credit card, pay day loan.
Most people would agree that carrying a high balance every month on a credit card at upwards of 20% interest is not financially prudent, but “good” debt can quickly turn into “bad” debt if not managed carefully.
Related: Why our debt-to-income ratio is misleading
Let’s look at two ways that this could happen – mortgage debt and student loans.
Mortgage debt
Owning your own home is a goal of most families (and singles, too) but would be impossible without a mortgage. Low payments from today’s rock-bottom interest rates make it achievable, and a home is an appreciating financial asset that increases in market value over time.
How can this be “bad”?
At one time people bought a “starter home” for their first house. Over a few years, as family needs and finances changed, this house was sold and the equity (read larger down payment) used to buy a larger home. This is no longer the case.
Many first-time buyers are jumping right into the larger “dream home.” They allow their mortgage lender to determine how much they should borrow and their real estate agent to talk them into buying the most house they can qualify for.
Related: How much house can I afford?
They allow the home builders to add unnecessary upgrades that will eventually cost 3-4 times the price of something that can be purchased later in a home improvement store (on sale).
They choose the lowest down payment and the longest amortization possible, and then worry about what will happen when interest rates rise.
They buy at the top of the market and may lose a considerable amount of money should they have to sell in a market downturn.
Student loans
Many studies have shown that a university graduate can earn over $40,000 in annual income than someone who just completes high school. Investing in yourself can have one of the highest pay-offs by increasing your value as a future employee.
Related: When doing what you love doesn’t pay the bills
However, with full-time university tuition in Canada averaging $5,600 a year, plus additional compulsory fees, books and living expenses bringing the total up to $15,000 a year or more, a student needs to study the right subjects.
One of the problems facing graduates is that they are often shocked to find out that they have spent four years learning about subjects that no one but themselves really cares about. A majority find themselves working outside their fields of study within two years of leaving school.
Students need to thoughtfully match their education and their desired career choices with their natural talents and abilities to increase the value of their contribution to a prospective employer in order to be a top earner.
The graduates I dealt with when I calculated their jaw-dropping monthly loan payments were not congratulating themselves on their sizable new salaries then. They were worried about making those payments, even with low interest rates and available tax credits.
Related: How fast should you pay off your student loans?
And, what if the student doesn’t complete his or her studies?
Final thoughts on debt
It’s unrealistic to ban borrowing money from our lives – debt can’t be avoided – but we have to be smart about it. So called “good” debt can turn into “bad” debt if we are not careful.
Buzzwords such as low interest rate, buy now/pay later, leverage, consolidate, payment vacation, tax deductible, and, yes, good debt, can mire us down into a situation that’s difficult to climb out of.
Related: Why a mortgage payment vacation is a bad idea
The RBC survey showed that 38% of respondents were very anxious about their debt. Debt can tie a person to an undesirable career, squash opportunities and create heavy burdens. What a way to live your life!
Debt of any kind should be seen as a short-term situation that always has an accompanying aggressive payment plan. It should be a means to an end that leaves you better off in the long-term.
- Borrow the least amount you can get by with by having realistic expectations and saving as much as possible yourself first.
- Borrow only what you know you can easily repay.
- Find the cheapest way of borrowing.
- Clear the debt as quickly as you can. Don’t stretch it out as far as possible. This includes constantly transferring and consolidating.
- Have an escape route in a worst-case scenario.
Related: How I plan to be financially free by 40
In my opinion, being debt-free is the ideal and the goal you should be reaching for.
I’m working towards becoming debt free one day at a time 🙂 Our only real debt is our house loan, and we’re in year 3 of 15 at having that fully paid off. Other than that, we’re saving like mad 🙂
@Money Saving: One day at a time is all you can do. Sounds like you’ll be debt free in no time.
Spot on about first timers buying the dream house Marie! In 15 years in the mortgage business I saw that all the time. No starter homes for this generation, they want to start at the top.
They buy at the upper range of their affordability (often higher through one means or another) certain that their finances will grow into the dream house. But that’s no longer certain today. And their situations are often complicated by large student loan debts.
A mortgage (or student loan) are only good debt if they’re taken intelligently, and in moderation. That’s not what always happens.
@Kevin: Thanks for backing me up through your own experiences. Borrowing a lesser amount and using more of your own money can make a big difference in the long run.
Stretching your finances too thin by purchasing all the wants instead of concentrating more on the needs can be damaging. Driving round in that lease vehicle won’t help your finances either. Keeping up with the Jones’s will do nothing for you other than dig a large hole you’ll struggle to climb out of.
@Canadianbudgetbinder: Well said.
I’d call them “debt” and “unacceptable debt” personally.
I also think that the person (home builder?) who started the ads implying renting was wasting your money and you could own for what you pay to rent is responsible for many bad decisions. How many people renting spend $200+ a year on flowers and decorations for the front of their home? Spend $185 to replace a toilet unexpectedly? Spend $30 every couple of years on snow shovels that have broken or been stolen? Spend $100 a year on energy to run a lawnmower? There are dozens, possibly hundreds, of minor expenses required to maintain a home that the average renter never notices.
@BetCrooks: Unfortunately, people get caught up in the promise of a better quality of life (not unlike bogus investment schemes) and don’t take the time to think it through properly. You’re right that you can’t just equate a rent payment with a mortgage payment.
The problem with the “get a degree that will actually pay you” is that most 19-year-olds (and, frankly, their parents) have a terrible sense of which degree is actually likely to lead to employment, and all of us are pretty bad at guessing which degree will be useful in 15 years. Nice study out of Georgetown recently (discussed on workopolis at http://www.workopolis.com/content/advice/article/was-studying-worth-it-the-university-degrees-with-the-highest-and-lowest-unemployment-rates/ if you don’t mind me inserting a link), showing that people with information systems degrees have a 14.7% unemployment rate, compared to 6.4% in drama and theatre arts. Now, some of those drama students are probably earning a low salary, but at least they’ve figured out how to be employed (and/or are willing to work for less in order to be in such an awesome field).
So I would argue that yes, it’s bad to have a sense of entitlement that any degree will guarantee you a job. But it’s also hard to guess which degree will lead to employment in the future… it’s kind of the educational equivalent of trying to time the market, if you think about it.
Strongly agree Gerard. And the rapid changes in employment, technology and global forces guarantee that careers will be even more difficult to predict going forward.
@Gerard: When I was in school a university degree made the difference from a high school graduate working their slow way up in a company or heading straight to the management training program fast track, with higher starting salary and more raises.
Now, secondary education is more the norm and it makes sense to consider where it will lead. You lower salaried drama students (and the like) can reduce student loans by saving more on their own, working part time and living with their parents where possible. Of course, this is true for all students – only borrow what’s necessary.
I’d hesitate to put a car in the category of “life’s important purchases” – although it certainly can be one of the large ones – a gift to ourselves that keeps on taking.
Even when not a luxury, this purchase will involve a fraction of the debt when bought used. I never have bought a car on debt – it is a laughably horrible proposition with depreciation rates, especially for new cars. However when I was struggling it was never beneath me to buy a beater for $2500 – probably a bit more nowadays to be roadworthy.
I know this sounds crazy on the surface, but I’m increasingly coming to view car loans – in moderation – to be good debt. Think about it, a car is one of the very few major purchases made that involves acquiring an asset used in the production of income (commuting to a job, running a business, etc). But again, only in moderation (short term, large down payment, secondhand car, etc). 90-100% financing on a brand new luxury car doesn’t fit the good debt parameter.
@Robert: I come from a generation that got the old family beater at 16, lives in the suburbs where stores are some distance away and would rather drive to work in 20 minutes than spend 90 minutes on public transit and transferring buses 3 times, especially in the winter – so, I would say a car is a necessary purchase.
That said, I have only taken out one car loan and that was when I worked in banking and had a discounted employee loan. Also at that time the average length of a car loan was 3 years. Now the terms can be 7 or even 10 years. If it takes that long to pay for a car it’s either too expensive for you or you’re keeping the payments too low.
We have our mortgage and one student loan, at 3.375% and 2.25% interest rates, respectively. I’d like to pay them off but they are manageable. Have not had any credit or auto loan debt in years.
@Money Beagle: So, you’re definitely not in the 38% who are anxious about their level of debt 🙂
I definitely agree with you there. I have too many friends that I went to Uni with are now stuck in dead-end jobs because they’ve decided to take Liberal Arts degree (I’ve still never figured out exactly what this is supposed to do) or Philosophy.
The basics such as Business, Engineering, Science holds a lot more opportunities than frivolous degrees. If that person doesn’t know what s/he wants to do, they should grab a good college diploma that can be applied to the real world while exploring other courses. This way, they’re not wasting their time!