Ending up with unmanageable debt doesn’t usually happen overnight. Instead, it’s often a slow, almost imperceptible trickle, that can start with being a few hundred dollars short every month, according to Scott Hannah, head of the B.C.-based Credit Counselling Society.
In the early stages, that gentle sloping toward the debt hole can be reversed. You can hunker down, tighten your belt, and dig yourself out.
Beyond a certain point, though, that becomes impossible, according to Doug Hoyes, licensed insolvency trustee and co-founder of Ontario-based Hoyes Michalos and Associates. You are just not going to be able to come out of it without professional help.
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So what are the signs that you’ve gone too far into the debt cycle to be able to dig yourself out on your own?
1. You are spending 20 per cent or more of your income on your consumer debt
Consumer debt includes credit cards, lines of credit and auto loans, to name just a few. And it generally comes with interest rates that are significantly higher than what you pay on your mortgage.
If keeping up with those debts is eating up 20 per cent or more of your paycheque, you have a serious problem, Hannah said.
While you may be able to get by for a long time, your debt servicing costs are making it impossible to set something aside for emergencies and unexpected expenses, he added. When life throws you a curve ball — you lose your job, your car breaks down, or your furnace stops working — you won’t be able to keep up.
Non-homeowners can think of it like this, according to Hoyes: If what you’re spending to service your debt is equal to half or more of your rent, you might want to seek help.
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2. It will take you more than two years to repay your high-interest debt
Another good way to tell whether or not you’re really in trouble is to ask yourself how much it would take you to pay off all your high-interest debt, Hoyes said.
You can use a debt repayment calculator like the one provided by the personal finance website of the Ontario Securities Commission. The software lets you add all your debts and then asks you how much you can afford to pay every month. Then it calculates how long it will take you to become debt-free.
If that figure is more than a couple of years, “you may have to reach out for help,” Hoyes said.
The longer you have to go, the harder it will be to stick to your repayment schedule and the higher the probability that you’ll end up taking on additional debt.
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3. There’s a pile of unopened bills and credit card statements on your kitchen table
Hoyes recalled a recent client who, when asked who he owed money to, simply dropped three envelopes on the desk.
“He hadn’t opened them,” Hoyes said. “He knew it was bad but didn’t want to look at it.”
Sometimes, not being able to dig yourself out of debt is a matter of pure math. But psychology matters, too. If you’re in denial and unable to face your debt on your own, you need someone to support you, Hoyes said.
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4. You are borrowing just to cover your older debts
Taking out a loan just so you can keep throwing cash at your older debt is a sign that you’ve probably reached a point of no return, both Hoyes and Hannah said.
In all likelihood, at this point, you are unable to borrow from a mainstream financial institution, so you turn to alternative lenders who promise fast cash and little or no credit check, Hannah said.
Those loans, often offered by payday lenders, come with interest rates as high as 59 per cent, which can quickly turn your debt hole into a crater, Hoyes said.
Often, it’s not how much you owe but how much you’re paying in interest that determines whether or not you’ll be able to repay your debt.
“It’s the debt-servicing cost that’s the killer,” Hoyes said.
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5. You are turning to payday loans
Payday loans tend to be the bottom of the debt cycle for two reasons.
The first is that, as Hoyes put it, a payday loan usually “isn’t the first loan you get, it’s the last.”
The typical client with payday loans that Hoyes sees typically has more than $30,000 in other unsecured debts.
“They’ve already got credit cards, and bank loans and taxes owing — and that hasn’t been enough to keep them going,” said Hoyes. “So now they’re resorting to payday loans.”
But even without a lot of preexisting debt, those who take out payday loans are often inexorably sucked into the debt cycle.
Payday loans are the ultimate debt-hole generators. Canadians can’t borrow more than $1,500 through a payday loan, but with interest rates averaging 400 per cent per year across the country, even small debts often spiral out of control, Hannah added.
You must pay back a payday loan when your next paycheque comes in. If you can’t make the payment on time, you face additional interest and fees. That’s why, often, people take out another payday loan to pay the previous one and quickly end up with three or four loans with triple-digit annual interest rates.
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Where to get help
One option is a Debt Management Plan (DMP), a service offered by non-profit credit counsellors. This often involves getting your creditors to agree to a lower interest rate on your debt and consolidating all your credit-card payments into a single, affordable monthly payment. The plan may cost you a small fee, depending on your income level and what you can afford.
A DMP also includes counselling services and financial education at no additional cost. Look for accredited credit counsellors through Credit Counselling Canada (CCC), a national association of 17 organizations.
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Another option is consumer proposal, a legal process that is only available through a licensed insolvency trustee. While a DMP can only lower your interest rate, a consumer proposal, if accepted by your creditors and the courts, can drastically cut down the principal you have to repay.
Hoyes said in his practice, borrowers who successfully proceed with a consumer proposal typically see the amount they owe reduced to one-third of the original debt. Like a DMP, a consumer proposal will also consolidate your debts into a single monthly payment, but that will also include fees and taxes.
According to MNP, one of Canada’s largest debt consultancies, a consumer proposal offering payments totalling $20,000 would deliver around $13,600 to your creditors, with the rest going to taxes and fees, including a $1,500 initial fee for the trustee.
Both a DMP and a consumer proposal will affect your credit record. A DMP will be dropped from your record two years after you’ve repaid your negotiated debt, according to the CCS. For a consumer proposal, it will take three years, according to Hoyes.
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A third possibility is declaring personal bankruptcy, also filed through a licensed insolvency trustee. This is the nuclear option when it comes to debt management.
The basic idea is you give up some of what you own in exchange for wiping out most of your debts. For a period of time, you may have to give up part of your paycheque to help pay off creditors. In most cases, though, you won’t have to give up your home — and you may even be able to keep your car.
A first-time bankruptcy stays on your record for six years after discharge, and you may be able to get a mortgage even before then.
All three options can help you make a fresh start and discover life after debt.
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