When your budget gets squeezed by all your obligations and you have more month left than money it can be a really tight spot to be in. Some of the typical strategies, rather than helping you, can lead to even bigger problems in the future. Here are the Five Biggest Mistakes that will keep you struggling with debt and how you can avoid them forever.
1. Adding More Debt
While adding more debt may resolve the issue in the short term, it will leave you wishing you could turn back the clock in no time.
Debt is essentially borrowing against future income at the cost of paying interest. Having done that in the past you may now be feeling the squeeze on your current income. Hitting replay and doubling down on debt – and interest payments – is not going to help. Now is the time to trim down the amount of debt you have by limiting your monthly budget to only the necessities and paying extra on your existing debt to bring it back to a manageable level.
2. Assigning Assets to Creditors As Security
When the creditors start calling with demands for money you don’t have they can become aggressive and often request that you give them security in any assets you might have that are not secured currently. Granting security means that you if you don’t pay your bill they will be able to take your assets. While this might get your creditor to stop calling for now the reality is if you could not pay before they took security likely you will continue to struggle to pay afterwards as well. Meanwhile, you are not free to do anything with those assets without their permission.
Your exempt assets are exempt from seizure, meaning your creditors cannot take these assets from you when pursuing collection of outstanding debts unless you’ve assigned them as security. Exempt assets include the following (in Alberta): $40,000 equity in your personal residence;
- $4,000 of household furniture and appliances;
- $5,000 equity in your vehicle;
- your RRSPs, RESPs and life insurance policies (with few exceptions);
- $10,000 worth of tools and equipment required to earn your living; and,
- specific farming equipment and land for farmers.
If you grant security in these assets your creditors will be able to take these assets if you do not make your payments.
It is important to remember that it is the equity in your assets that determines the amount of the exemption. Equity is the value of the assets over and above any outstanding loans that are secured by that asset. For example, if your home is valued at $350,000 and the balance due on your mortgage is $310,000 then you would have $40,000 equity in your home which would be exempt from seizure by your creditors.
3. Taking Out A Consolidation Loan
People sometimes take out a loan to consolidate their debt in the belief that it would be easier to make one monthly payment. This definitely can be helpful however the most important step to making this arrangement successful is closing all other credit facilities: credit cards, lines of credit, etc. Your consolidation loan should be paid off in its entirety before obtaining more credit (see “Adding More Debt” above).
4. Negotiating a Home Equity Line of Credit
A home equity line of credit is a consolidation loan that is secured to your home as a second mortgage. If you are already struggling to manage your debt getting a secured line of credit against your home is a very bad idea because it is a security on equity that may well be exempt (see the previous two points above). What I see happen time and again is people end up paying their minimum payment on this line of credit indefinitely which means this mortgage will never be paid off. This goes against the primary reason to buy a house in the first place: making a long-term investment. You invest your money in equity in your home to have it grow over time but if you get a secured line of credit the only money that is growing is the bank’s money and your investment becomes more of a burden then a nest egg.
5. Selling Assets
Using RRSP’s or RESP’s to pay off your debt is very convenient given the liquid nature of these investments. This may be entirely appropriate but if it is just a bandaid – ie. you continue to maintain debt but you think that it will buy you some time to get things under control, then you may want to think again. Check our blog HERE about this topic which goes into more detail.
When you start considering divesting your assets or refinancing to stay afloat be sure to get professional advice to ensure that you are going to fix the problem instead of delay it.
A Trustee in Bankruptcy can provide you with all your options for consolidating or eliminating your debts. Before jumping from the pot into the fire seek professional advice to make sure you solve the root issues. If you would like some more information on your own personal circumstance let’s chat.
Rebecca Frederick, CIRP Trustee in Bankruptcy
Frederick & Company Ltd.