The first commandment of personal finance is not to carry a balance on your credit card.
If you have just recently seen the light when it comes to keeping track of and improving your personal finances, then you might have a pesky credit card balance that keeps weighing you down.
One of the main reasons all money experts agree that not paying your card off every month is a terrible idea, is because of the high annual interest rates that are applied to that borrowing. But with Canadians currently holding over $80 billion in credit card debt, (according to Equifax) at a rate of 19.9% or higher, the amount of interest people are paying for the privilege of not paying back the credit card company in full at the end of every month generally dwarfs the interest rates charged on other lending. Interest rates on things like mortgages, car loans, student loans, and lines of credit are almost always significantly lower than the ones on credit cards.
Consequently, if you’re like many Canadians who have accumulated credit card debt, it might be to your benefit to look into combining your debt into one easy-to-pay off loan or line of credit.
NOTE: Here is what NOT to do: Use a loan to wipe your credit cards clean, then proceed to ignore that loan AND dirty up your credit card balance by using them and not paying them off again at the end of the month. If this seems like an extreme situation, you should know it’s not as uncommon as one might guess. If you have created a set of unrealistic consumer spending habits for yourself it can be very difficult to reform those tendencies overnight. So, no matter what solution you choose in terms of paying off your credit cards, DO NOT then go and reverse all of your good work by continuing to borrow at high interest rates.
Related: Getting Started With Student Debt, TFSAs, RRSPs, and HISAs
Using a loan or line of credit to consolidate (aka bring all of your credit card debt to one place) has two primary purposes:
1) By putting all of your debt in one place, it gives you a more accurate portrayal of how much money you have actually borrowed. It also makes it a much simpler process to pay off if you only have one number and one account to focus on.
2) Chances are that the new loan or line of credit will likely have a lower interest rate than your credit card balances do. This means that when you make your monthly payment, more of your money will go towards paying down the actual money you borrowed (called the principle), then it would if you were still paying the higher interest rate on your credit cards; therefore, you can pay off your debt quicker for the same amount of money out of your pocket.
If you are carrying a balance on your credit card, you may want to consider the new “Marketplace Lending” model that has caught on in the UK and USA, and is becoming more popular in Canada. You might have seen commercials for these types of companies such as Lending Club and/or Prosper on American TV stations.
Marketplace Lending is not code for “magical solution”. You will still owe just as much money as you did before, but the idea is to make it cheaper and easier to pay off that debt. In most cases marketplace lenders provide a much better solution than payday loans. (Click here if you have not seen the John Oliver piece on payday loans and the insane world they inhabit.)
Canadian marketplace lenders such as Borrowell present an option that is competitive with products your bank offers, such as a line of credit. The basic idea is that the company facilitates the transaction between lenders and borrowers. Similar to the sharing economy concept of Airbnb, Borrowell matches institutional investors looking to lend with people who are looking to borrow. By operating exclusively online, the cost and complexity of lending is reduced fairly significantly and the savings are passed on to the borrower. Borrowell’s Interest rates start at 5.6% APR, with their average customer receiving 13% interest rate.
I think it’s certainly worth comparing what your financial institution has to offer versus what the marketplace lenders are putting out there. Saving yourself a few percentage points on your interest rate can mean a few hundred – or even thousand – dollars in your pocket.
Related: Is Debt a Deal Breaker?
Marketplace lenders are really targeting the Gen Y demographic (most of us have a bunch of debt and don’t mind conducting business via the digital world on our laptops/tablets as opposed to physical space of a banking branch) and cater to our habits. They offer 3 or 5 year fixed-term personal loans that you can apply for online without a lot of a trouble.
Fixed-term loans are a great option for paying off your credit card debt. What happens is that a lender will front you the money to pay off your credit card debt. They’ll set you up with a monthly payment plan that will allow you to pay a set amount every month and consistently climb out of debt – sort of like a student loan or car loan. Say goodbye to making minimum credit card payments that have no set terms for repayment!
John owes $3,500 on credit card A, $700 on credit card B, and $4,300 on store credit card C (store credit cards are often the worst, having interest rates in the 28-30% range). They all have different interest rates that are above 18% and require John to try and prioritize payments every month – which he finds a headache.
If John were to take out a fixed loan, he would now owe $8,500 all in one place, at an interest rate of say 10%. He would make one monthly payment if he wanted to, and could pay more off if he had the money at any given point. This keeps things simple and easy to keep track of. With one goal in mind, John might find it easier to focus and stay the course.
Of course John has to keep one thing at the forefront of his quest to get out of debt: DON’T start to carry a balance on his credit cards again!
Remember, debt consolidation is a massive business and it is quite lucrative. There are thousands of companies set up to “help you” with your debt. Spend the time investigating new options like marketplace lending and see if it might be a good solution for you! The good news is, even if you just want to check what kind of rate you’ll get, you can do it quickly online and it won’t affect your credit score.
And once that credit card is paid off, do not, I repeat, DO NOT go back to carrying a balance!