July 15, 2o20
Today: Good debt vs. bad debt — and yes, there is a difference!
The third in a three-part series by John Moakler, BMath, CFP, CLU, CSC
With many people out of work, or with their income drastically reduced, the pandemic is the time to manage your cash flow more carefully than ever. And, with our opportunities to spend so drastically reduced, new spending habits are taking shape — so this is the perfect opportunity to think about making them permanent. Today, we look at good debt vs bad debt — and yes, there is a difference!
Nobody is going to knock on your door and say, “I would absolutely love to buy your credit card debt.” Likewise, don’t hold your breath for someone to ring your doorbell and announce that they want to buy your car loan. So you can understand why we consider these kinds of debt to be “bad.”
However, somebody will indeed knock on your door and offer to buy your home. Your mortgage in this instance is, clearly, “good” debt. Making that debt even better, the value of your home will generally increase over time.
So, be more willing to incur good debt than bad. And, look at restructuring your bad debt. For example, if you own a home with a mortgage — and you have a car loan, or you’re having difficulty paying off your credit card on a monthly basis — look at consolidating these debts into your mortgage payment. Why? Because credit cards have incredibly high interest rates, and also because interest on your credit card and car loan is compounded monthly — or in some cases, daily — which makes the overall bill higher. Interest on a mortgage, on the other hand, is only compounded semi-annually, which will serve to shrink your overall debt.
Here’s something else: more than 50% of home owners who have paid off their mortgages have a Home Equity Line of Credit (HELOC) with an outstanding balance. Are you one of them? If yes, your outstanding balance can be in the thousands or hundreds of thousands of dollars. The interest rate on a HELOC is compounded daily, and what often happens is that you get into the habit of only paying the interest each month — which compounds your debt problem even further because you are not paying down the principal.
If you have a mortgage and not a HELOC, you can be much better off — because every payment has some portion going to pay interest, and also a portion that goes to paying down the principal.
If you truly want to get a handle on your expenses during the pandemic — or at any time, for that matter — seek the advice of a professional Certified Financial Planner (CFP) or Chartered Life Underwriter (CLU), two crucial certifications I have earned. Get help with developing a monthly budget. Most financial planners have developed their own tools or templates to help you with the budgeting process.
BMath, CFP, CLU, CSC
President and Senior Executive Financial Planner
Moakler Wealth Management Inc.
1 416 840 8544