Too Much Debt Use This Rule To Find Out

Canadians are carrying more debt than ever, which has left many wondering if they might be in over their heads. It’s in situations such as these that people begin comparing their finances with that of their family and friends, hoping to gain a clearer picture of how much debt might be too much. However, because everyone’s situation is unique, that is rarely an effective strategy.

Making sense of debt requires understanding how different factors influence how much any one person can afford to borrow at any given time. These include an individual’s household income, their marital status, geographical location and the financial demands they face at various life stages (e.g. student, mid-career, retired etc.). At the very least, it requires people be aware of how much debt they are carrying and how that compares to their monthly income.

Consider the following examples:

Note: These case studies outline fictional scenarios and are intended for illustrative purposes only.

Amy has a $5,000 income tax debt. Her chequing account is $1,100 into overdraft and she owes $23,000 on her credit cards and lines of credit. She also has $37,000 in secured truck and ATV loans. Her net monthly income is $5,400 and her general monthly expenses are $5,150. She is married, rents her home and lives with her husband and daughter.

Bruce owes $13,500 on his credits cards. He is $750 into his overdraft, but he has no secured vehicle loan or mortgage. He has a net income of $2,025 month and his general monthly expenses total $1,900, which includes essential expenses for a medical condition. He is a renter and lives alone.

Cheryl owes $7,500 on various credit cards and pay day loans. She has no secured vehicle loan or mortgage. Her fixed pension and social assistance income totals $890 per month, while her general expenses are $1,275 per month. She is a renter and lives alone.

Darren owes $150,000 between his credit cards and lines of credit. He has $30,000 in secured vehicle loans and a $175,000 mortgage. His assets include $65,000 in exempt, locked in RRSPs and pension plans, $40,000 in house equity and $25,000 in shares from a private company. His net income is $6,500 per month and his general expenses are $4,750 per month. He is married, lives with his wife and plans to retire within the next year.

Each of these people have noticeable differences in debts, assets and cash flow, but they also have one very important thing in common: Each meets the definition of an insolvent person as set out in the Bankruptcy and Insolvency Act. None of them are able to pay their debts as they become due. Each has stopped making payments in the ordinary course of business and they all have unsecured debts totaling more than $1,000 and / or the total value of their assets does not exceed the total value of their debts. So, it is possible a bankruptcy or consumer proposal could be filed in all of the above cases to provide relief from debt.

Reviewing Your Own Situation:

The easiest way to determine if you’re too far in debt is to use the 40 per cent rule. If the amount of money you spend to cover your monthly debts – such as credit cards, lines of credit, vehicle loans and mortgage – is less than 40 per cent of your before-tax monthly income, you most likely have control of your debt. However, if that number is higher than 40 per cent, it is unlikely lenders would be willing to extend you further credit and indicates it may be time to think about a repayment strategy.

Here are some additional warning signs you may be carrying too much debt:

• You are making payments on one debt using another form of credit.
• You have only made the minimum payment on your credit cards for more than three consecutive months.
• You pay for groceries and other essential items on credit without a plan to pay the charges at month end.
• You are borrowing money from friends or family.
• You have had to use pay day loan services and/or you have had to access credit from high interest lenders.
• You have received collection calls or letters such that you’re afraid to answer the phone or open your mail.
• You don’t know your monthly expenses nor how much money you have in the bank at any time.

There is no “one-size-fits-all” approach to getting out of debt, but recognizing that you may be in a period of financial difficulty is the first step in finding a solution. Every situation is unique and meeting with a Licensed Insolvency Trustee is the first step to identifying which options may work best in your own unique case.