Paying off debt is the number 1 financial strategy in Canada! Why? Because debt that bears interest is costly, taking more from you every month than most investments will pay you, especially after tax.
Debt is also restrictive. It will limit you from doing other things that might become a priority. It may deny you the opportunity of making a profitable purchase or investment or business expansion. You may be denied credit to make some incredible deal. You may run into bad times and still have to make your debt payments, when you have other priorities needing payment. It can stress you and your family out.
Having a good credit rating and borrowing capacity is a great asset – allowing you to take advantage of those opportunities that come along – like buying the neighbour’s car that is just coming off lease, or purchasing the lakefront property alongside your country house. Better still, you might borrow to buy company shares if they are offered, or a rental duplex that you could manage in spare time. In the case of shares or rental properties, the interest on your investment loan will be tax deductible. If the loan costs you 5% per annum, this will be reduced to 2½% after deducting interest from your taxable income.
So now you are conflicted. We said getting rid of debt was the priority. But now there are some good reasons for borrowing. Which is it? The answer is to be careful and smart about borrowing. Borrow what you can afford to repay easily from your monthly cash flow. Plan on repaying the debt quickly. Borrow only for high priorities items that will increase in value, that will reduce your cost. Arrange your borrowing so that the loan is for investment or business purposes, not for personal uses. That way the interest will cost you 50% less.
Taking a mortgage to buy your residence is an example of a good loan. Not because it will go up in value – it may over time. Over the last 50 years, house values have gone up quite a bit, with only a few lulls in the upward price rise. But in the 400 years since records were kept in Amsterdam house prices have risen at the rate of inflation. And costs of maintenance, repairs, improvements, taxes, etc. may exceed the increase in value for certain holding periods.
Owning your own home provides peace and security, and the regular mortgage payments are a great discipline to save and invest in home equity. Just work on paying off the mortgage in as fast a time period as possible. Then your credit worthiness will increase: you paid off the mortgage, you have all that home equity. You will be free to improve the property, buy another more suitable home, or make other investments.
Having a large debt load today can become a real burden. We are expecting interest rates to move up substantially over the next 3 years. If that happens, your debt payments will rise, making it harder for you to meet your monthly payments. With recent low interest rates, it has been a low cost borrowing time. But don’t get used to it, or you may find yourself in trouble.
In the end you will need to make smart decisions about the use of your precious cash flow. Buy only what you need and can afford. Use cash to buy, and bargain hard to keep costs down. If you must take on debt, make sure that payments fit in your budget, and work to pay it off quickly – Pay cash for personal needs, and borrow for business and investments. Stay living within your means and you will find you have the cash or borrowing capacity to buy what your need. And if you are in a debt pickle right now, sit down with your adviser and work out a plan to start decreasing it right away.
