Your credit is maxed and you can’t repay the debt. What next?
Walloped by high interest rates, inflation, and the lingering financial and job effects of the pandemic, many people (especially young people) are financially drained, and in too much debt.
If you’re nearing the end of your available credit, these are your options to take control of your money and avoid costly mistakes.
Get organized
Inventory what you owe (the balances), to whom (the lenders), the monthly payments and the interest rate on each. I recommend listing all debts in a spreadsheet and noting what the total limit is on each credit product. This will give you a sense of how near the end of your credit you are. Tally up the total amount of debt owing and how much you are currently paying every month to service all the debts. Compare this to your total income and other spending. Are there some quick budget cuts you could make that free up money to put toward your debts?
If you experience anxiety with this task, it is completely normal. Your stress will start to reduce once you have an honest look at the situation in its entirety. If you skip this step, your stress will undoubtedly increase.
Get your credit report
You are entitled to a free copy of your credit report each year. You can order this through Equifax or TransUnion. Read it carefully. Any errors could give future lenders the wrong impression of your financial situation. The government outlines a step-by-step credit report error-correction process and it is key to get on top of these corrections pronto. Your credit report feeds into your credit score, which lenders review, and if you’ve got a lower score (less than 650), it’s going to be very difficult to qualify for consolidation loans or lines of credit at reasonable interest rates.
The keys to improving your credit score are paying your debts on time, making full payments, and not maxing out your available credit (in other words, keeping a healthy level of available balance). Your score will improve over time.
Explore consolidation
Consolidation rolls your debts into one loan that should be at a lower interest rate, and at a lower total payment, than what you are currently paying for both. This should free up some cash flow to help balance your household budget, and it should also feel like a much more simple financial structure to manage — one loan versus many loans. There are traditional consolidation loans with banks and then there are lines of credit (LOCs) used for purposes of consolidation. Both will work, but my caution is this — LOCs are revolving, which means you can almost always borrow back what you’ve paid. Be super mindful to end the cycle of overspending so you’re actually paying down the balance owing. Mindful spending should also be the goal with a consolidation loan, otherwise you’ll end up needing another one.
These days I’m seeing family members offer private consolidations, which might be a good avenue to explore if you can handle the strings attached with a family loan.
Show me the money
Sell that Pilates reformer or massage table. Take on extra shifts. File your taxes (you’re statistically likely to get a return). Claim your benefits reimbursement. Cancel any unnecessary spending. Do whatever you can to raise extra money. These funds can go toward the highest-interest debt payments or toward your living costs so that you don’t incur more debt.
Lastly, a consumer proposal
Sometimes there is no other path forward — you can’t keep up with the payments and are unable to consolidate or bring in more cash to service the debts. Working with a licensed insolvency trustee (LIT) to prepare a consumer proposal (or a debt-management plan) could be the right next step. Consumer proposals allow you to repay only a portion of the debt, get protection from creditors and hold the interest charges. The payments are more manageable and once you’re through with repaying the proposal, the LIT files the paperwork to release you from your debt. There’s a long road ahead to rebuild your credit, but over time with a strong history of good debt management, your score will improve. A consumer proposal results in the second-lowest rating on your credit report. Bankruptcy is the lowest rating, and most severe option. In both cases, they offer near-immediate relief from the debt.
Because credit counselling is generally part of these solutions, there can be greater long-term financial wellness on the horizon with stronger money habits like budgeting and managing new credit responsibly.
One of the most-asked questions I get as a financial educator is how to permanently end the cycle of debt and overspending. The answer is simple — save a little bit each day. Saving even $1 a day starts to build financial security, and eventually the savings grow to be enough so that consumer debt isn’t required anymore. Saving is also very helpful in squashing bad spending habits because it introduces a healthy motivation to keep your hard-earned money rather than spend it on frivolous things. So, see what you can do to set aside a few dollars daily as you’re on this important debt-reduction journey.
This article was originally published in The Star. Lesley-Anne Scorgie is a Toronto-based personal finance columnist and a freelance contributing columnist for the Star.
