With the start of the global recession at the end of 2008 as the world markets collapsed, millions of Canadian families came face-to-face with severe financial distress. Most of this distress was caused by debt and in particular, too much unsecured debt from overspending on credit cards. Even now four years later, the average Canadian family owes $1.54 for every dollar of income they bring into the household. As a result, families in Canada continue to struggle to reduce debt in order to regain financial control.
All of this financial hardship caused by debt may make it seem like debt is the enemy of a stable financial outlook, but in a real sense not all debt is bad debt. In fact, the way the credit and credit reporting systems are set up in Canada, you are almost required as a consumer to take on at least some debt in order to be financially successful. Otherwise, you have no credit rating. This can lead to difficulties with everything from making big-ticket purchases to renting an apartment or getting a rental car on your next vacation.
So if not all debt is bad debt, the topical debt management question is how can you tell which types of debt are good? What’s more, how do you protect yourself so you can avoid problems that arise when you have too much debt?
Often times, debts are good debts because holding debts of these type can actually have a positive impact on your credit scores. Debts like your mortgage and your auto loan are counted as positive factors on your credit history when lenders, creditors and other businesses run a check your credit. This is why the types of debt you carry actually account for 10 per cent of standard FICO credit score calculations. Holding debts like a mortgage and a car loan can mean you enjoy higher credit scores.
By contrast, debts like department store credit cards and specialty store credit cards are considered bad debts, because of the extremely high interest rates and strict terms of repayment that most cards of this type carry. Since these debts don’t look as good to creditors, carrying large amounts of debt on cards like these has the potential to hurt your credit scores. Any business that reviews credit reports would view these kinds of debts as a sign of an increased risk consumer who may not be as responsible paying off the debt.
Another important factor in separating good debt from bad debt is the amount of debt you hold. For instance, a mortgage is a good debt in general, but if you have a bad mortgage with terms that don’t work for your budget or you purchase a home that’s beyond your means, you can end up in a bad situation with debt even though a mortgage is a good type of debt to hold.
The same can be true with credit card debt. Credit cards from major credit card issuers in Canada are better to have than specialty store credit cards. However, if you are carrying too much credit card debt even if it’s with a major card issuer, it’s almost always going to mean you are considered a high-risk borrower.
No matter which types of debts you carry, you should never allow the total monthly payments on your debts to exceed 36 per cent of your monthly income. More debt than 36 per cent usually means that you are verging on financial hardship, because your debt payments are going to start reaching a point where you are struggling to keep up. If you have more than 36 per cent of your income being used on debt payments, you need to develop a strategy to reduce your debt burden quickly or look into options for debt relief.
This is a guest post provided by Consolidated Credit. You can follow them on Twitter.