Snowballing debt

Tips on how to get back in the black

According to Statistics Canada, household debt levels in the country have risen to a record high of 163 per cent of Canadians' disposable income.

Yet that doesn't mean debt has to be a burden. In fact, it is far easier to get out of debt than most people think. You just need the right strategy.

While there are many ways to get out of debt, there is one that seems to work more
effectively than the rest: the modified snowball technique. The standard snowball technique suggests paying off the lowest balance debts first and then using the money freed up from those debts to help pay off the next lowest balance debt until all of the debts are paid off. This technique ignores two important factors: which debts will free up the most cash flow and interest rates.

To make the snowball technique more effective, analyze the payment-to-balance ratio and move higher-interest debts to lower-interest credit products.

To determine the payment-to-balance ratio, divide loan or credit card payments by their respective balances. The debts with the higher ratio are the debts you want to pay off first, freeing up the most cash flow and allowing the snowball to work faster.

The second step is to evaluate the interest rates of all the respective debts. Chances are you will find the higher-interest-rate products will also have the higher payment-to-balance ratios.

The goal is to move higher-interest-rate debts to lower-rate products.

For example, consider moving a normal credit card with a 19 per cent interest rate to a low-interest-rate credit card like the one offered by ATB at 9.9 per cent.

The bonus of moving to a low-rate card is the lender will often offer an introductory interest-free period. The ATB card, for example, offers a six-month interest-free period, allowing borrowers to transfer their balances from non-ATB credit cards with no upfront costs.

Borrowers could also go one step further and open an even-lower-interest-rate line of credit through a bank.

By transferring existing debts to lower-interest-rate products, be sure to reassess the payment-to-balance ratios, making sure to pay off the higher-ratio products first.

While looking at lower-rate products, also make sure to stay clear of products that seem too good to be true. For example, a consumer proposal may seem like a good option that provides a little bit of a break, but it is treated by lenders as if it were a bankruptcy, which will prevent you from getting lower rates and potentially other loans all together for the next few years.

For borrowers with home equity, refinancing the debt into a mortgage can free up cash flow and significantly ease the burden. This should be a last, but very effective, resort if there is more month than money at the end of the month.

Nolan Matthias holds a Bachelor of Arts Degree in Economics, is the co-founder of Mortgage360, and the author of The Mortgaged Millionaire.

* This content was produced by CREB®Now's advertising department, in consultation with Mortgage360. CREB®Now's editorial department was not involved in its creation.

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