8 truths and misconceptions about debt

The COVID 19 pandemic has a lot of people worried about their finances. There's no getting around the fact that many people are watching their debt grow right now, even with the relief measures and support available. Read on for 8 common ideas about debt-some true and some false-and advice on how you can avoid taking on too much during these uncertain times

Updated May 8, 2020

Test your knowledge: true or false?

1. Your debt-to-income ratio is calculated by adding up your monthly debt payments and dividing that amount by your monthly income.

True. If you have $1,100 in monthly payments (things like your rent or mortgage, credit cards, car loan, student loan, condo fees, electricity, taxes and so on) and a gross salary of $3,333 a month (before tax and deductions), your debt-to-income ratio would be 33%.

Your debt-to-income ratio (the 33%) tells you how much of your monthly income goes to paying back debt. It can also help you see if you’re getting in over your head, so you can adjust your budget as needed. Financial institutions use this ratio to calculate your ability to repay your debt (your creditworthiness).

The lower your ratio, the easier it should be for you to make your payments. In you’re worried about your debts right now, start by taking a look at your budget. Calculate your debt-to-income ratio, then see if you can cut any unnecessary expenses. You can also figure out which debts you should pay off first.

Tools to help you get started:

2. A debt-to-income ratio under 40% is generally considered okay.

True. As a general rule, a debt-to-income ratio under 30% is considered excellent, while a ratio between 30% and 35% is considered okay. Things get a little worrisome if your ratio goes over 40%. A higher debt-to-income ratio means you might not get approved for a loan (like a mortgage, student loan or car loan) and you could have a harder time paying it back. Unlike your credit score, which is based on your credit history, your debt ratio is based on your current situation (income and expenses).

Advice for the COVID 19 pandemic

You probably have a lot on your mind right now, trying to stay healthy-don’t add financial worries to the mix! We recommend doing what you can to keep your ratio under 35%.

Before getting into any more debt, check our relief measures - This link will open in a new window.. You might be eligible for help with your credit card, insurance, mortgage, personal loan or personal line of credit. We also offer emergency loans.

3. Co-signing a loan will affect your debt-to-income ratio.

True again! For example, if you co-sign a car loan for one of your kids your debt-to-income ratio will be affected, even if they make every single payment on time.

In other words, co-signing a loan affects your creditworthiness-which could be an issue if you also need a loan. That’s because the loan you co-signed is included in your debt-to-income ratio. Of course, things could also become tense if the person you co-signed for is late on their payments.

4. Student debt should be paid off before any other debt.

False. As a general rule, it’s better to pay off debts with higher interest rates before debts with lower interest rates or those with tax-deductible interest-like government-guaranteed student loans - This link will open in a new window..1

COVID 19 and student loans: Government relief measures

Payments on all government-guaranteed student loans have been suspended for 6 months. The government has deferred all student debt, which means you don’t have to make any payments and you won’t be charged any interest. This relief measure applies even if your account is in collection. You can use this break from your student loan payments to pay off other debts.

5. To keep money-related stress to a minimum, you should have an emergency fund that can cover 3 months of expenses.

That’s true. In a perfect world, you’d always have 3 months of expenses socked away in case of the unexpected, like a job loss, a break-up, an illness or other financial hiccup.

The current situation is proof that having an emergency fund can be worth the initial sacrifice and extra discipline. Remember though, it’s never too late to get started! When you can, open an account to be your designated emergency fund, then set up regular automatic deposits.

6. A credit card is a good solution for unexpected expenses.

False. Although credit cards can be handy for minor emergencies, if you don’t pay the full balance (amount owing) by the due date every month, you’ll get hit with interest charges. If something big and unexpected happens, like losing your job due to COVID 19, you shouldn’t be using your card.

If you think your credit card is your only option, speak to your financial institution. They can tell you about other options that could help you pay off your card faster and get a lower interest rate.

If you’re not able to pay off your credit card in full every month, choose a card with a low interest rate. Over the medium and long term, even a slightly lower rate could save you hundreds-or even thousands-of dollars.

7. If you make an extra payment or pay a higher amount one month, you can skip your payment the next month.

False. You’ll decrease how long it takes to pay back the entire loan (known as the amortization period) and pay less interest, but unless you change your loan contract, you still have to make your monthly payments. Any missed payments will be considered overdue.

8. The trick to saving is simply to spend less than you earn.

Well, yes, that is true. But it’s also true that spending less than you earn isn’t always easy-especially when you’re facing a lot of uncertainty, like we all are at the moment. But if you’re able to take control of your savings and expenses, you’ll see the difference in your account balance and your stress levels!

If your goal is to reduce your debt, you may find it helpful to call your financial advisor. They’ll help you understand your situation and find the right strategies.

Right now, every little bit counts. Take care of yourselves!

1 In the form of non-refundable provincial and federal tax credits.