Do debt right

Financial Literacy Week 4: How to get good debt and ditch bad debt

Ruth Saldanha 28 November, 2019 | 1:36AM

 

 

Ruth Saldanha: It's the final week of Financial Literacy Month here in Canada. And the theme for this week is debt. Debt is a huge problem for many Canadians. We owed roughly $1.74 for every dollar of disposable household income. This debt was spread over mortgages, consumer credit and nonmortgage loans. If you're feeling overwhelmed, don't worry, Karen Wallace is here to help. Karen is Morningstar's Director of Investor Education and she's here today to talk about debt and how to deal with it.

Karen, thank you so much for being here today.

Karen Wallace: Thanks for having me, Ruth.

Saldanha: Debt is an emotional issue for many Canadians. So, it's important to ask, is all debt bad?

Wallace: Well, you know, it depends what you mean by bad. There are some schools of thought that say there is good debt and that's debt that has the potential to produce sort of a higher income stream in the future. And by that, I mean, an advanced degree could do that, education could result in a future earnings stream that's higher, you know, a higher salary. Or if you buy a property that you could rent out, that could produce an income stream as well. So, I mean, there are things that are considered good debt, but there are also bad investments that can be considered good. Taking on too much debt of any kind is not good in any way.

Saldanha: At the same time, many of us have multiple debts, credit cards, mortgages, car loans, personal loans. In what order should I repay my debts?

Wallace: The highest interest rate, that could be the one to tackle first. Because that balance is growing at a faster rate, that debt balance. There are other schools of thought that say that maybe you could prioritize the smallest balances first. As long as you're obviously meeting the minimum payment on all your other debts, prioritize the smallest balance first, which will give you sort of a series of like psychological wins along the way, which can be really motivating to continue along with a debt repayment plan. But I mean, you have to sort of come up with a way that makes sense for you.

Saldanha: Credit cards have high interest but offer easy money. Earlier this month, we talked about emergency funds. Can a credit card or a home equity line of credit be a good substitute for an emergency fund?

Wallace: You know, Ruth, I wouldn't recommend a credit card as an emergency fund substitute and it's exactly for the reason that you mentioned. Every $3 carton of milk you buy is really $4.50. I mean, a credit card is a really expensive way to pay for things. So, any money that you can sort of siphon off into an emergency fund, even if it's $1,000. If you find yourself without income, if you lose your job, if you have sort of a financial emergency that comes up and who doesn't, then you'll know that you have that set aside, so you won't have to be depending on credit card and higher interest loans to kind of just pay for necessities along the way.

Saldanha: Finally, should I repay my debt, or should I invest?

Wallace: Well, there's a lot of very good opinions on both sides. And I think at Morningstar, we've done some research on, if you have student loan debt should you invest for retirement alongside it? And I think it depends on the interest rate obviously on the loan. But a lot of times it does make sense to sort of pay down your student loan and invest for retirement alongside just because the earlier you start investing for retirement, the higher the potential payoff is. So, it can make sense depending on your situation.

Saldanha: Thank you so much for being here this week, Karen.

Wallace: Thank you so much, Ruth.

Saldanha: For Morningstar, I'm Ruth Saldanha.

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Ruth Saldanha

Ruth Saldanha  Ruth Saldanha is Senior Editor at Morningstar.ca