Debt literacy 101: Your guide to tackling debt with confidence

Debt is a common reality for many Canadians, whether it’s a mortgage, a car loan, or a credit card balance.

And while debt can be a useful tool for achieving financial goals, managing it effectively is crucial for your long-term financial health. Unfortunately, many Canadians struggle with debt, often feeling overwhelmed by high-interest loans or unsure of how to best pay it down.

In this blog, we’ll explore the concept of debt literacy, focusing on unsecured versus secured debt, strategies for paying it down, the dangers of high-interest short-term loans, and how to avoid debt relief scams.

Unsecured debt vs. secured debt

Understanding the difference between unsecured and secured debt is essential for building a solid financial foundation. Here’s a break down:

Secured debt

Secured debt is backed by collateral, which is an asset you own, such as a home or a car. In the event that you fail to make payments, the lender has the right to seize the asset to recover the debt. The most common example of secured debt is a mortgage. Other examples include car loans or secured lines of credit, where your car or home may be at risk if you default on payments.

Unsecured debt

Unsecured debt, on the other hand, isn’t tied to any collateral. Credit card debt, personal loans, and student loans are examples of unsecured debt. Since unsecured debt is riskier for lenders — they have no collateral to seize — interest rates tend to be higher. If you fail to pay unsecured debt, lenders can’t take your property (absent a Court Order), but they can take legal action to recover the money. This, in turn, could negatively affect your credit score.

Understanding these differences helps you prioritize which debts to focus on first, depending on your priorities. Typically, because secured debts have lower interest rates, unsecured debts — especially those with high interest rates — should be paid back sooner to reduce your financial burden.

Strategies for paying down debt

If you find yourself with manageable debt, creating a strategy to pay it off can help you maintain or regain control of your finances. Here are some popular methods for tackling debt:

1. The snowball method

This method involves paying off your smallest debt first while making minimum payments on others. Once the smallest debt is paid off, you move on to the next smallest debt, and so on. The psychological benefit of this method is the motivation that comes with seeing debts disappear quickly.

2. The avalanche method

This strategy focuses on paying off debts with the highest interest first, regardless of the balance. Mathematically, this is the most cost-effective way to reduce debt, as it minimizes the total interest paid over time. Once the high-interest debt is paid off, you move on to the next highest-interest debt, continuing until all debts are cleared.

3. Consolidation loans

Debt consolidation, or balance transfer, involves taking out a new loan to pay off several smaller debts. Ideally, this loan has a lower interest rate than your existing debts, which allows you to save money in interest. However, consolidation loans come with their own risks to carefully consider. Before you sign on the dotted line, ensure that the new loan's terms are favourable, avoid accruing new debt, and make sure you can afford the payments while covering your other expenses.

Be wary of using high-interest short-term or consolidation loans to pay off your credit card debt or manage unexpected expenses, as these can quickly spiral into a debt trap. Watch out for lenders that have the words “easy,” “fast,” “quick,” or “instant” in their advertisements or business name, and/or those that boast that everyone is approved — there’s likely going to be a high interest rate despite a quoted low monthly minimum payment.

4. Budgeting and lifestyle changes:

Alongside these strategies, creating and sticking to a realistic budget is essential. Evaluate your spending habits and adjust to free up more money for debt repayment. Small lifestyle changes, like cutting unnecessary subscriptions or dining out less, can lead to significant debt repayment progress over time.

Additionally, government assistance programs or community-based organizations might provide emergency financial aid or low-interest loans to help you through tough times.

Avoid debt relief scams

Debt relief scams are, unfortunately, common, especially for individuals struggling with significant debt. These scams often promise quick and easy debt solutions for a fee, but they rarely deliver on their promises and can make your financial situation worse.

Here are some signs of a debt relief scam:

Upfront fees: Reputable debt relief services don’t charge fees until they’ve helped you settle your debt.

Promises to eliminate all debt: Be cautious of any company that guarantees they can eliminate your debt quickly or for a small fee.

Pressure tactics: Scammers often use high-pressure sales tactics to get you to sign up for their services immediately.

Unclear information: If a debt relief company is vague about their services or fees — or if they don’t provide clear, written contracts — it’s a red flag.

Please keep in mind that only Licensed Insolvency Trustees (LITs) can administer Bankruptcies or Consumer Proposals in Canada. If they advertise that they are an LIT company, you can quickly verify by using the search function through the Office of the Superintendent of Bankruptcy.

How to protect yourself on your debt relief journey

If you are seeking debt relief help, the best way to protect yourself is to talk to an LIT. Consultations at MNP are free and an LIT is required to review all of your options to deal with your debts.

If you aren’t quite ready for that — make sure to research and avoid companies that ask for large upfront payments. And ensure you check out their Google reviews. You may also want to consider seeking free or low-cost advice from non-profit credit counselling agencies like the Credit Counselling Society or Money Mentors.

Take the first step with MNP

Being debt literate is crucial in today’s financial world. By understanding the different types of debt, creating an effective repayment strategy, and avoiding high-interest loans and scams, you’re set up to regain and maintain control of your financial situation. And whether you choose to use the snowball method, explore your options with an LIT, or make small lifestyle changes, you’re already taking the most important step — you’re taking action.

If you’re struggling with debt, it’s never too late to start moving toward financial freedom. By becoming more informed and staying vigilant, you can reduce your debt burden and create a healthier, more secure financial future.

Reach out to us today for a free, no-obligation consultation to discuss your debt management needs.

Lindsay Burchill is Vice-President, Insolvency, at MNP Ltd.