Debt Managements

How to budget to pay off debt

Having a budget can help you achieve your debt repayment goals faster and more consistently by giving you a structure you can use to allocate your money as needed.

With a comprehensive budget, you’ll have a solid understanding of how much money you earn each month, how much you spend, and where you spend it. It also helps you determine how much money you can set aside to pay off debt and how much you can apply to savings (such as emergency funds) and investments (such as retirement accounts).

It also lets you know how much extra you have in the budget to spend on “non-essential” expenses like vacations or entertainment.

In this article, we’ll cover how to get a good understanding of your debt, how to budget for your debt repayment, and effective debt payoff strategies so you can get out of debt and anxiety.

Understand your debt

Debts can be classified as secured or unsecured.

  • Secured debts. This refers to any form of debt backed by some form of collateral. For example, the collateral on a car loan would be the car while the collateral on a mortgage would be the house.
  • Unsecured debts. This is a debt that is not backed by collateral of some kind. Credit cards are an example of unsecured debt. Interest rates on unsecured debt are often higher because there is no collateral to offset the lender’s risk.

So, what types of debt should you prioritize? Here are some examples of debts to help you decide which debts to pay off first:

Payday loan

Credit card

Car loan

Mortgage loan

April interest rates

about 442%

Usually 19.99% to 25.99%

About 8.24% as of January 2024

Varies with terminology. Between 5.52% and 8.73% in 2023

Risks on collateral

no direct risk

no direct risk

Danger to the car

Danger to the house

Penalty for non-payment

Penalty fees (maximum varies by province)

Interest charges on the outstanding balance

Collection procedures

A lawsuit for non-payment of debts

Late fees and potential interest rate increases

Collection procedures

A lawsuit for non-payment of debts

Report non-payment to credit bureaus

Late payment fees

Possibility of recovering car ownership in case of delay for several months

Report non-payment to credit bureaus

Late payment fees

Possible foreclosure on the home or other legal actions such as a Selling power

Report non-payment to credit bureaus

Which of these debts should you pay off first? If your goal is to reduce the money you spend on interest fees, payday loans should be paid off first. Next would be credit card debt. Meanwhile, for car loans and mortgages, you must set aside enough money to meet the minimum monthly payments.

However, if your financial priorities are to qualify for another loan (such as a consolidation loan), increase your credit score, or reduce credit utilization, you may want to prioritize paying off other debts first, since payday loans do not report to credit bureaus .

How to budget for debt repayment

When preparing a budget to pay off your debt, it’s important to start by analyzing your income and expenses. Here, free tools like Credit Canada’s Budget Planner can be helpful.

One traditional way to budget is to follow the “50/30/20” rule. What this means is the money you earn:

  • 50% will go towards “needs” such as housing costs, food, your car, etc.
  • 30% will go towards “wants” such as entertainment, travel, subscriptions, etc.
  • 20% will be allocated to savings and debt repayment.

How do you determine how to classify needs versus wants?

“It’s very easy to confuse a need with a want, especially if it’s something we really want. So, an easy way to consider the difference between needs and wants is Do I need this to survive?“~Jordan Kaye, personal finance writer

It’s important to find the right balance between paying off your debt and saving for the future (or even for your personal financial goals).

In addition to the 50/30/20 rule, there are other budgeting systems, such as “zero-based budgeting,” which aim to use every dollar you earn in some capacity — even if the spending is in the form of contributions to debt payoffs, savings accounts, or investments.

There is also a “money bucket system”, similar to the envelope system, where you can set up different bank accounts or envelopes for different types of expenses to set a maximum limit on your spending for each type of expense.

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When setting up your debt repayment plan, try to set a goal that follows the SMART framework (i.e., Specific, Measurable, Achievable, Relevant, and Timely). For example, “Pay off my student loan within the next 10 years.” This helps you stick to your payment plan over the long term.

Effective debt repayment strategies

Once you know your income and minimum monthly expenses and how they align with the 50/30/20 rule, it’s time to choose a debt payoff strategy. Here are two different payment strategies to choose from:

  • Snowball method. Pay the most money you can on your smallest debt, regardless of the interest rate, while keeping your other debt payments at a minimum.
  • Avalanche method. Put as much money as possible into your highest-interest-rate debts first while keeping payments on other debts minimal.

These methods have different benefits. For example, the avalanche method tends to save more money in the long run, while many find it easier to stay motivated using the snowball method because debts go away faster when you focus on the smallest debts first.

Tips to boost your debt repayment strategy

To help improve your debt repayment strategy, consider following these tips:

  • Reduce expenses. To help make room in your budget to pay off your debt more quickly, identify unnecessary expenses and reduce them as much as possible. Reducing expenses allows you to allocate more money to pay your debts so that your debts are paid off faster.
  • Use “side hustles” to increase your money. Make more money by participating in the gig economy (companies like Uber, Turo, and Skip the Dishes), reselling vintage collectibles online, or making items to sell yourself on platforms like Etsy. Just make sure you file your taxes from your side hustle!
  • Use the windfall to clear debt first. When you receive a lump sum of money (such as an inheritance or a lottery win), it’s often better to use that money to pay off your credit cards or other high-interest debt than to save or spend it.
  • Benefit from debt consolidation. Debt consolidation is when you take multiple debts and combine them into one payment. This could include debt consolidation loans, debt consolidation programs/plans (DCPs), or transferring debt into your mortgage.

“We don’t see debt management as an area of ​​saving. However, the best way to save is to eliminate debt.” – Mike Bergeron, Credit Consultant, Credit Bank Canada

Maintain your budget and debt plan

After you settle on a debt repayment strategy (or combination of strategies), it’s important to stay on track with your repayment plan. Some quick tips for staying within your budget include:

  • Get help. Maintaining a budget can be difficult. But you don’t have to do it alone. Seeking help, whether from friends and family members or professionals like accountants, financial advisors, or nonprofit credit counselors, can help you stay motivated and find better ways to manage your money to get out of (and stay in) debt.
  • Review your debt status periodically. Track all of your debts and review them at least once a year so you can address changes in your debt situation and change priorities as needed to keep your repayment plan on track.
  • Use a budget app. There are apps you can download to your smartphone or other mobile devices that can help you track your spending habits, alert you when you’re over budget, or find opportunities to reduce your expenses. Many financial institutions have their own apps dedicated to this purpose.
  • Set up payment reminders. Create reminders in your calendar about payment due dates to avoid missing payments on your debt.
  • Use automated payments, if available. To make it easier to make consistent payments, consider setting up automatic payments to creditors.
  • Consolidate your debts. The less debt you have, the easier it is to keep track of it and make payments. Debt consolidation helps reduce the total number of payment due dates you have to keep track of.

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