A while back on this site I wrote about my distaste for debt. For example, our bank owns close to half our home. Sure, there is “good debt” such as borrowing money for an appreciating asset (like a house) but a mortgage limits our cash flow for investment purposes, even with the low mortgage interest rates of today. Debt payments limit some of our options on how we can spend our money and therefore our time. Without debt, our income could be used to buy more appreciating assets (like more dividend paying stocks or equity ETFs) to fund our financial future. Instead, a good portion of our income services debt today. With debt we pay other people first.
Recently Statistics Canada announced that the ratio of household debt to disposable income in households rose to record levels. Credit cards are the usual suspects when it comes to debt, with mortgages and lines of credit along for the ride. I suspect it’s easy for folks to fall behind on debt payments because using credit is just so damn easy.
How could you get out of the red and into the black? Here are two suggestions and things we’re doing for what it’s worth.
1. We budget, kinda
We don’t use a formal budget but we do forecast expenses on a bi-weekly basis. Here is an example of what we do:
We ensure we spend less than we make every month. You can also see in this table that pay ourselves first. Paying ourselves first is part of our budget forecast. Some of our funds go to savings for upcoming expenses. Some of our funds go to fun (i.e., REDBLACKS tickets). Some of our funds go directly to investments, including dividend paying stocks and indexed ETFs.
2. Our take on debt stacking vs. debt snowball vs. highest interest debt first
With the debt stacking method there is a list of all debts from the highest interest rate to the lowest, and minimum payments are made on all of them. Extra cash is diverted to the highest interest rate. You work your way down the debt list from there.
With the debt snowball method you focus on killing your small debt first, working your way towards the highest payment. The idea here is that paying off a small debt can build momentum and snowball your way to larger debt issues.
Then there is the method of simply focusing on your highest interest debt and slaying that dragon first and foremost. Again you can work your way down the debt list from there.
Personally, I don’t think there’s an absolute right or wrong way of tackling debt. We’re fans of getting rid of all high-interest debt first. That means we strive to never carry a balance on our credit cards. If we have any outstanding on our line of credit that is tackled next. Lastly we pay down the mortgage including the use of mortgage prepayments after contributions to investing accounts such as TFSAs are maxed out.
Those are things we focus on. Stay tuned for part 2 of this debt theme where I discuss making debt tax-deductible and where you can learn more about managing debt.
How do you tackle debt? Are you out of debt now?
Mark
My name is Mark Seed - the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, I'm looking to start semi-retirement soon, sooner than most. Find out how, what I did, and what you can learn to tailor your own financial independence path. Join the newsletter read by thousands each day, always FREE.
Just out of curiosity. How is all of your debt tax deductible? I could see the homeline if it was used to invest in non reg investments, but not the personnel loan and mortgage?
Good catch Joseph, to be acurate I should say 70% of debt is tax deductible. Mortgage will be done soon so I dont bother. Personnal loan is a bit different. My dad sold a plot of land last year and prefered to make a deal with me. I pay the same rate as I would get after tax deduction. It’s a way to diversify my debt and both of us are happy this way.
Le Barbu, what are your thoughts on the Smith Manoeuvre – thereby making your mortgage debt tax-deductible? Here was my take:
https://www.myownadvisor.ca/should-i-implement-the-smith-manoeuvre/
I have another article coming up soon on debt, about making mortgage debt tax-deductible via this method. Another form of leverage that can work if one is a) savvy and b) for the most part, fortunate with their stock selections 🙂
Mark, I read this article last year when doing my “home work” about SM. I admit my plan is not the real SM but my version. I kept a 20k$ buffer on purpose. Beacause I capitalize the interests, HELOC used for SM will increase at the same rate our mortgage decrease over 7 years or so. Depending of the future rates level, it may take 10-15 years before the HELOC is topped. I use the dividends to improve our cash flow. The real SM seems a lot of work (buying often, paper tracking) and it’ a turn off for me.
Thanks for the clarification. The reason I asked was I used a portion my HELOC – watered down SM. to buy some dividend players this year, and wasn’t aware of any other way to make debt tax deductible. So far I’m happy with how it is working out, I’m not even looking at capital appreciation, just happy with net return based on tax deductible interest and dividends of 1.4%.
Gotcha, basically using your HELOC but not doing the entire SM. I agree, the audit trail would be a big PITA (pain in the a$$) so I don’t do it because a) my wife and I have don’t want more leverage/debt and b) the hassle isn’t really worth it.
Maybe when our mortgage is under $50k with borrowing costs low, I will consider it. Then again, it might be fun to be totally debt-free 🙂
I have a post coming up soon re-visiting the Smith Manoeuvre whereby you can make your mortgage debt tax-deductible.
https://www.myownadvisor.ca/should-i-implement-the-smith-manoeuvre/
Borrowed funds for investments purposes, make the interest paid on the loan tax-deductible as well Joseph. Generally speaking, you can deduct interest on borrowed money used to earn income from a business, or property. Income from “property” includes interest income, dividends, rents and royalties.
Stay tuned for my next post 🙂
I neither hate nor love debt. It is a tool, use it wisely and correctly and it should work well. Watch out if one abuses it though.
Just as a funny aside….I just spent 30 seconds trying to delete what I thought was a double period at the end of the last sentence. I thought my keyboard had finally filled up with enough dust and cookie crumbs that is was broke. Turned out to be a dot on my screen.
For sure Lloyd. We’re trying to use debt as wisely as possible although for two of us we probably have too much house. That will be addressed in the future at some point but for now we’re very happy to live here while working.
As for the aside, I have that problem often. Our kitty cat loves to hang out around the laptop screen!
That was an awesome conversation. Thanks for sharing Le Barbu and Mark.
Glad you enjoy it. I need to respond to Le Barbu’s last comment.
While not fully comfortable with my plan years ago, my wife is more confident now. She would have been easier to convice to buy a cotage for 150K$ instead of investing. Her family would consider this a wise move and congratulate us.
Working with leverage takes some confidence, and guts, and sometimes a bit of luck as well. For now, our home remains our largest debt and we’ll work on killing that as we invest in 2016.
Mark, I like the way you “don’t budget” 😉 For many years now, I just transfer my checking account on an Excell form and extrapolate the future months/years. This way, I know in advance our cash flow. Most expenses are the same and I adjust for big and uncommon ones. Actually, its done until march 31th 2018…
Would you mind to give us an idea of your debt/assets/NW picture ?
1-debt is xx% of total assets
2-assets are: house, RRSPs, TFSA etc
3-saving rate is xx% of income
4-minimum debt payments represent xx% of income
5-marginal and average tax rate
6-life insurance coverage (xx% debt or xx% income)
Without revealing personal informations, we could benchmark some key financial items
Thanks. It’s simple but effective.
Well, I disclose a great deal on the site so I prefer not to say – so thanks for understanding. I will say we have mortgage debt (see link) and a small car loan that will be paid off within the year. That’s all the debt we have.
https://www.myownadvisor.ca/write-investing-200000-debt/
Assets include home, pensions and invested assets.
I think our savings rate is nearly 20% net.
https://www.myownadvisor.ca/new-savings-rate-10-folks/
We have >$500k life insurance to cover existing liabilities. We intend to self-insure in another 10 years or so.
“Sure, there is “good debt” such as borrowing money for an appreciating asset (like a house)…”
I can’t believe people still believe this. The marketing is powerful on this one! A house is a depreciating consumer durable. Think of it as a utility, not an asset.
“…the ratio of household debt to disposable income in households rose to record levels. Credit cards are the usual suspects when it comes to debt, with mortgages and lines of credit along for the ride.”
Since 2000, mortgage debt has tripled, with LOC and CC debt taking a double; assume the rise in LOC is attached to the rise in mortgages. The dangerous part is that CC debt is unsecured. Most debtors could probably pay off all mortgages and LOCs if they sold their house.
My view is that the only good debt is debt used for production; all other debt is bad.
Don’t take my debt comment out of context SST. An appreciating asset implies you can accurately predict the future. Houses are an asset albeit an utilitarian one as in, you have to live somewhere. Folks “banking” on their house prices rising significantly are gambling IMO.
“Since 2000, mortgage debt has tripled, with LOC and CC debt taking a double; assume the rise in LOC is attached to the rise in mortgages.”
We were in far more debt in 2010 than now. I hope it’s the same story in 2020 vs. 2015.
Debt used my corporations is a bit different, for production purposes, wouldn’t you agree?
Mark
Trying not to throw an argumentative tangent into the flow, I will agree to very strongly disagree on the housing matter (taken in context) and your view “An appreciating asset implies you can accurately predict the future”.
(The quoted debt levels were for national levels, not my personal levels (yikes!). )
I’ll stick to my guns in that the only good debt, personal or corporate, is that which is used for future production and not consumption. Almost all personal debt falls into the consumption category, thus bad debt. Perhaps ‘good’ and ‘bad’ should be stricken from the financial lexicon in replace of productive and non-productive. If it’s not debt for production then all you’re doing is shifting future production to the present.
There’s a reason Buffett loves production assets and discourages leverage.
I have no problem with your “the only good debt, personal or corporate, is that which is used for future production and not consumption.”
You are welcome to your opinion!
Where we agree is likely taking out this ‘good’ and ‘bad’ debt from our lexicon and Buffett is wise (who is to argue with him) when it comes to leverage (i.e., don’t do it for the vast majority of investors – you are investing money you don’t have).
Debt should also be the lowest rate you can get and tax deductible if possible.
The debt debate polarization leads to weird situations. I know people who crunched their mortgage furiously but have no E.F. and no investing. They were so thigh on their budget they had to finance a car recently and delayed their utilities bill. On the other end, some others are so leveraged, if rates go up for 1% they are doomed. A co-worker bought a lifetime insurance for the kids but never put a dime in RRSP, RESP or TFSA. Can we get a bit more balanced approach?
I think a balance sheet has to be in line with each situation. Always think about short, mid and long term. Not an easy task, especially because personal finances are not taught in school, most cant help their kids because they are clueless, money is a boring subject for many and finally, confusion of 2 simple words: personal and private.
My parents were Debt-Averse, saved to pay cash for everything from cars to house. They once bought a car financed @ 0% while having enough cash in their checking account. After 3 months, they finally went to the dealer to repay the loan entirely and get rid of the monthly payments, it was making them sick to owe money. My wife’s family use to finance everything they can: cars, ATV, home renovation, furniture etc. We are both from middle class families who used very different paths. When talking about debt, it’s often black or white and no shades of gray between the extremes.
I am naturally attracted by the “Debt is Evil” side of the Force but through the years, I learned to use debt like any other tool in my finance toolbox (and as just another four-letter word!). If well handled, debt can help to increase NW and improve cash-flow. When making financial decisions like buying a car, a house, a stock ETF, a Disney vacation etc, it has to be in line with your goals/plan in the first place. Paying cash does not make a bad decision better and financing does not fade a good decision.
Most business have a debt policy and use debt in order to maximize growth and investments while staying solvent and liquid enough at any moment. The perfect debt level and structure vary by sector, size, etc. Why does individual should not do the same? Our actual debt is about 20% of our assets (or 30% of our NW) and monthly payments represent 10% of our income. The interest rate is 2.05% now (prime – 0.65%) and they are fully deductibles from our incomes (38% marginal rate) so a net 1.27%. I believe we can get returns to offset this…
Someday, we may de-leverage but right now, I consider our debt to be a useful tool for us.
Interesting to read those differences Le Barbu. Debt, like investing, seems to be a polarizing topic for sure.
I don’t see all debt is evil but I know for us to get to our goals, we can’t have any or at least very much of it. People will disagree with me on that and that is OK by me.
Maybe eventually I will use debt as a tool as well but until our mortgage is next to nothing we decided not to borrow any more money.
How much are you leveraged can I ask? $50K? $100K? More?
Our total debt is 240K$ (150K$ HELOC, 50K$ mortgage, 40K$ personal loan)
Our total assets are 1.1M$ (600K$ registered, 150K$ taxable, 350K$ house)
Our investments are 30%ZCN, 25%VTI, 20%VBR and 25%VXUS (no bonds) and average MER is 0.15%. US and International holdings are in our RRSPs and ZCN is held in RESP and TFSA for tax efficiency. I try not to re-balance but to buy the lagging index with new contributions to reduce transaction cost.
E.F. worth 3 months expenses and saving rate is always +/-40% for 15 years now.
My wife and me started our financial journey together with a +75% leverage (70K$ mortgage, 20K$ car loan, 100K$ house, 20K$ RRSP) back in 1999. Our mortgage rate was 6.55% and debt payments represented 25% of our income. We never borrowed again for a car or any other consumer goods. We focused on saving, investing reducing expenses (taxes, fees, transport cost, insurances etc) so our leverage decreased over time. Now, our principal target is to keep improving our total cashflow until F.I.
That mortgage is next to nothing – well done.
Great work on the assets. Our house is worth a bit but I’d rather focus on invested/investment assets. Our goal is to have at least $1M to retire on to churn out >$30k per year.
https://www.myownadvisor.ca/dividends/
Those ETFs are great. Your emergency fund is intact, great work.
I like your call to improve cash flow over time. That is our plan as well so that eventually we can live off dividends and/or distributions.
If cash flow improve and you manage to lower your income and investment taxes, invest through diversified low fee index etc, then leverage (HELOC or mortgage) is not a big deal in the 10-40% ballpark.Once we hit the 25% mark, we slowed down a bit because it was not our weakest point anymore.
I’ve talked with my wife about this and she is certainly not comfortable with more debt while the mortgage is in the six-figures.
I think once the mortgage is close to done we’ll consider borrowing to invest to make the interest tax-deductible. It will be much lower risk with the mortgage at $25k or even $50k.
We are in the position where we have no debt. No mortgage, cars bought for cash and so on.
That zero percent car purchase is probably one area where we would consider taking on debt, but like your parents I would be cautious to the point of checking other purchase costs against the interest that could be earnt by putting that $30,000 into savings..
I have never trusted my investing prowess enough to consider taking a loan to fund the purchase but what you say makes good sense.
. .
That’s an excellent position! We hope to be there in another 10 years – pay cash for stuff – no debt including no mortgage.
I think a 0% interest car isn’t that bad of a decision as long as you intend to keep the vehicle for at least 10-12 years. We do.
Until our mortgage is next to nothing Richard, we won’t be into leveraged investing.