Budgeting vs. Debt Consolidation

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Budgeting vs. Debt Consolidation

Written by Chrissy Kapralos
Fact-checked by Caitlin Wood

Budgeting vs. Debt Consolidation

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Budgeting Debt Debt Consolidation

You can rarely go through life without having some debt. People experience debt with credit cards, student loans, mortgages, car loans, medical bills, collections agencies, and more. It’s common, inevitable, and manageable if you take the right steps toward managing your finances and spending. Poor debt management can cause a host of physical, mental and relationship issues. Our advice is to consolidate your debt for yesterday’s mistakes and start budgeting for tomorrow.  

Control Debt With a Budget 

Less than half of Canadians, or 49%, operate their finances with a budget. Some of the reasons behind not using a budget include a lack of time, finding it boring, or feeling stressed out at the thought of managing finances. However, budgeting is necessary for a healthy financial life because it :

  • helps you pay your debts
  • reduces spending 
  • tracks expenses
  • helps you save and plan for your future
  • improves your net worth
  • keeps your financial goals on track

Budget Strategies – 50/30/20

While there are various strategies to operate your budget, a popular one is the 50/30/20. This strategy splits up your income (after tax) into three categories: 50% on what you need, 30% on what you want, and 20% for the savings and debt payments. With this strategy, you can look at your expenses and examine where you’re spending too much. 

Needs (50%)

Your needs are non-negotiable, meaning you can’t avoid paying them – things you need to live like shelter, groceries, and utilities. If you’re spending over 50% of your after-tax income on what you need, you might consider downsizing your apartment for cheaper rent, being more thrifty with your groceries, or taking public transit instead of driving.  

Wants (30%)

Your wants are everything that isn’t essential. Nights out, entertainment, games, alcohol, vacations, upgraded television sets, and expensive gym memberships. For many wants, there are ways around getting rid of them completely. For example, you might cook dinner at home and light some candles instead of going to a fancy restaurant. You might skip on a vacation this year, or decide to work out at home instead of the gym. 

Saving/ Debt Repayment (20%)

Your savings include investments, like RRSP payments, emergency funds, and debt repayment. Debt is counted into this category because paying them results in less interest, which helps you save. 

While the 50/30/20 strategy has been shown to help manage debt, it’s important to tailor your budget to your own needs. You can still splurge and enjoy yourself once in a while, so long as you’re on financial track for the most part. 

Check out how you reach F.I.R.E (Financial Independence Retire Early).

Professional Support

If you’re finding it hard to stick to your budget and pay off your debts, there are many professionals who work to help people with debt, such as credit counsellors, financial advisors, and even some therapists. They can assist you in evaluating your finances and helping you tailor the budget to your needs. 

Budgeting Apps 

Out of the 49% of Canadians that use a budget, 20% of them use a digital budgeting tool or app. While traditional methods of budget keeping, like writing things down, can still be effective, digital tools are becoming increasingly common because they take care of the organization part of budgeting for you. With a budgeting app, you can feel more organized and knowledgeable about your finances. This rings especially true if you have your own business, as many budgeting apps have accounting features to help you manage your business costs, ledger, payables and receivables, and tax considerations.

Debt Consolidation 

If you’re deep into debt, it might be overwhelming to look at your various credit cards, lines of credit, and loans with all of their separate interest rates. If you find yourself riddled with many different kinds of debt, you might consider a debt consolidation loan. 

Debt Consolidation Loan

Offered by various banks, credit unions and online lending firms, a debt consolidation loan is similar to a personal loan and credit card in the way that it is unsecured, meaning you don’t need to put up collateral.  Its main purpose is to consolidate, or combine, multiple debts into one loan. By combining your debt into one balance, you can acquire a lower interest rate to help ease the financial burden of your various debts. The monthly payment is often lower than other loans, but they also tend to have longer repayment periods. Despite the lower monthly payments and interest rates, it’s important to evaluate the term of the loan to calculate how much interest you’re paying in the long run. You also want to watch out for loans with good rates only at the beginning of the term, as they can increase drastically throughout the term length or loans with many administrative fees. 

Types of Debt Consolidation 

Personal loan 

Personal loans can be used for any purpose, and are offered by most financial institutions. Most personal loans have reasonable interest rates, and no need for collateral; however, you’ll need to provide proof of income and a decent credit score to be considered. Make sure you take a look at the term length of the loan – you’ll want to evaluate the amount of interest owed over time and compare it to your other debts. 

Home Equity Loan

If you have a property in your name and have paid off a few years of your mortgage, you might be able to borrow against the equity in your home with a home equity loan. Since the loan is secured by your home, this type of loan doesn’t require as high a credit score as a personal loan would, and doesn’t have as high-interest rates. Although you might be able to consolidate your debts by borrowing from your home, it’s important to consider potentially high closing costs associated with this loan before making a decision. 

This shouldn’t be your first option, mainly because it poses a few risks. If something happens to your income and you can’t make your payments, you will risk your property. Additionally, you could owe more money than your home is worth if property values go down. 

Learn the difference between a HELOC and a home equity loan.

Balance transfers

Ideal for people with multiple credit cards with different card providers, a balance transfer if often quickly approved, and doesn’t require collateral. A balance transfer entails taking the balance of one credit card and adding it to the balance of another. To do this, you need to have a high enough credit limit on the card you plan to transfer your balances to.  Although balance transfers often require a 3-5% transfer fee on the amount of money you plan to transfer, the appealing part is that you can secure a lower interest rate, making it easier to pay off your debt faster. Since your interest rate might not apply to anything bought in addition to the balance transfer, it’s best to use this option only if you have a way to pay for things without using the credit card in question. 

Find out if you should use a balance transfer or a personal loan.

Debt Management Program

A debt management plan is a service offered by a credit counselling agency to help clients pay off all of their debts within a 5-year period. They are ideal for people who aren’t able to qualify for a debt consolidation loan and provide a scheduled plan with fixed payments to a consolidated balance, consisting of your debts pooled together by the agency. 

ProsCons
Ease collections agency callsNegatively affects your credit score for a period of 2-6 years
Lower interest ratesRequires you to pay 100% of all of your debt
Single monthly paymentsNot ideal for complex debts, like student loans
Available even if you can’t qualify for a debt consolidation loanHigh monthly payments 
Not legally binding

Consumer Proposal

Similar to a debt management plan, a consumer proposal is filed with a Licensed Insolvency Trustee and helps consolidate and resolve your debts. However, agencies offering consumer proposals negotiate with your creditors to help you pay only a portion of your debts and the rest of the debt is forgiven. Consumer proposals have saved people up to 70 cents per dollar on the debt they owe, though settlements are dependent on your financial situation – income and assets. 

ProsCons
Government-sanctioned, legally bindingNegatively affects your credit score
Not required to pay all debts in full, forgiven on some debtLong process
Works for most debt, even complex ones like  tax debt
Avoid bankruptcy
Ease collections agency calls

Final Thoughts

Being in debt doesn’t have to be scary. With strong budgeting and tailored loans that fit your personal needs, you can stay on top of your debt and finances. If debt consolidation loans and budgeting still isn’t enough, there are other debt-relief options to consider, like debt settlements or bankruptcy. With any debt-relief option, however, you’ll want to consult with a credit counsellor. 


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