Escaping Debt Podcast – What NOT to do when debt is out of control – Episode 3

Knowing what NOT to do when your debt is out of control is arguably more important than knowing what to do. Why? Well – a very large amount of people spend a very long time struggling with debt before they even realize they have a problem. Let’s dive into it in this podcast.

Transcript

David Moffatt (00:00):
Hello, everyone. I hope you’re doing exceptionally well today. Welcome to the Escaping Debt podcast. Today we’re going to be covering an interesting topic surrounding the idea of what options exist when debt is out of control. And kind of paired with that, we’re going to talk about what not to do when debt is out of control.

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David Moffatt (00:19):
My name is David Moffatt, I’m your host today. I’m a senior debt relief specialist and the local director of Four Pillars Halifax. Our goal is that no consumer should have to struggle with the burden that debt causes. We believe that it is simply not possible for a company to represent both the consumers and the creditors at the same time in an unbiased fashion. That’s why we work for you, not your creditors.

David Moffatt (00:42):
So this is going to be a really interesting topic and what I’ve seen in my time, having now sat in front of thousands of people to review their debt relief options and help them with their debt is that there’s a lot of things that people do that they probably shouldn’t do. And there’s a lot of things that people do that they should be doing. And so hopefully we can cover off a lot of these things. And I think kind of paired with this, we can also break down each and every option that exists in the debt restructuring world.

David Moffatt (01:18):
Now, as we go through this, remember that we’ve covered a lot of this stuff extensively on our blog. So you just go to Halifaxdebtfreedom.ca/blog and you’ll see all of our articles that are there.

David Moffatt (01:31):
So what are some things that people do that they shouldn’t be doing when their debt is out of control? This is a great question. Now, before we get there, let’s first cover off, when do you know if debt is out of control? Now, this is actually an extremely interesting question, because it’s really subjective and really depends on individual circumstances.

David Moffatt (02:00):
So to define it loosely, if you’re struggling to pay your debt the way it’s intended to be paid, then your debt is out of control. Meaning that if you can only make interest only payments and nothing more, if you struggle to make payments at all, or if you know it’s been four or five years, your debt hasn’t decreased at all, it might be slowly increasing over time, in my opinion, your debt is out of control. To go further with this, if at any point in time, it would take you more than five years to pay off your unsecured debt, then chances are your debt is out of control.

David Moffatt (02:51):
Now this is a really good indicator and the reason why we have a five year limit is because most of the restructuring methods that we’re going to talk about today, will have you debt-free in five years or less. And so very rarely makes any sense to take out debt or to try to tackle debt in a period of five years or more. And we’ll kind of get into exactly why as we walk through this stuff. So what are the things that you really shouldn’t be doing when debt’s out of control?

David Moffatt (03:24):
So the first thing that you really shouldn’t be doing is not giving it the attention it deserves. What I mean by this is that a lot of people, if they get hurt, they obviously rush to the cabinet, they get the bandaid. They go to the hospital, they see the doctor. People are very, very concerned about this type of stuff. If your car breaks down, people will rush to get it fixed because they need it to go to work.

David Moffatt (03:52):
Well, your finances are almost the same. You need your finances to be in place properly and effectively in order to live life in a meaningful way. So don’t not give it attention. I know it might seem bad and it might seem like there’s no end in sight, but sitting down, going through your past spending, coming up with some sort of a budget and a plan and then tracking and making sure that you actually stay on top of that plan is paramount to your longterm success. And I don’t necessarily mean just getting out of debt. I mean, for the rest of your life.

David Moffatt (04:36):
It’s interesting because every successful individual I know from a financial perspective, they make budgets for their personal life, their businesses, or whatever other endeavor they’re actually going to be working on. They’re probably at a point in their life where they don’t need to have a money management plan. They could probably just go and spend money as they want to, but they still do it. And so it just goes to show the power of planning.

David Moffatt (05:05):
So that’s number one, you should not, not give your finances the attention they deserve. You should be giving your finances more attention than most things in your life. Now I don’t necessarily mean from an actual time commitment. I mean, simply from a mental effort commitment.

David Moffatt (05:29):
So how do you actually do this? So, it’s actually quite simple. What you do is you sit down, you review the last 12 months of your expenses. You make a plan, a spending plan, also known as a budget with that information. And then you track it moving forward. I recommend that you look at your bank account on your phone, or however other way you want to do it at least three times a day.

David Moffatt (05:53):
When you wake up, at lunch or around, and then before you go to bed, that way your finances will always be top of mind. And then at least on a weekly basis, I want you to go through and review your spending and actually write down where you spent your money. Even if it just means you are copying, essentially copying your notes, like you would have done in school. It helps you remember them, and it helps you stay present. This trick alone will help you quite a bit.

David Moffatt (06:22):
So the next thing not to do when your debt is out of control is to get too sucked into the “the screw it” factor. And what is this the “screw it” factor? Essentially it is the concept that at a certain point in time an extra $40 of debt doesn’t really matter. Okay. And so you say, screw it, it’s only an extra $40. I’m already 20 grand in debt, so screw it. I’m just going to put it on the credit card. And usually this is said in much harsher words, but for the sake of the podcast, we’re going to stick with screw it. And this concept is actually a little damaging and the reason why is because when you think of your behavior, when you try to create a habit of something, you’re actively trying to change the way you do something.

David Moffatt (07:22):
And so if you spend extra money under this screw it factor, you’re more likely to continue doing that. And it kind of devalues your position. Every dollar counts. And what I find is that the more people think about their money, the more good decisions they make about their money, naturally more good decisions are made down the road.

David Moffatt (07:49):
Now this sounds like common sense. And honestly it is, but most people, when they’re struggling, when they’re deep in debt, they know it, they have the screw it factor and they kind of ride that screw it factor for a little bit of time. Now, you can’t do it forever, of course. And it’s completely natural for this to occur, but you want to try to escape it as quickly as possible. The sooner you escape it, the sooner that you sit back and you go, “Okay, I can’t keep living like this. I’m going to look at my bank account. I’m going to look at my spending. I’m going to try to break the paycheck to paycheck cycle. I’m going to try to save money.” The sooner you do that, the better off you’ll be.

David Moffatt (08:38):
So, [to recap, the] second thing to not do when your debt is out of control is kind of be encompassed and swallowed by this screw it factor. The first one is to not, not pay attention, enough attention to your finances.

David Moffatt (08:55):
So the third thing that people should not do when their debt is out of control is to not save money, meaning they should save money, if I’m mixing my negatives here a little bit. And you’ll actually hear this advice by some financial professionals, they will say, “It makes no sense to save money right now, you have debt.” I have a really hard time with this because I have seen client after client, try their absolute darnedest to pay off their debt and then they keep getting hit by life.

David Moffatt (09:38):
You know, the car breaks down. The house needs a repair. The hot water tank goes. They might have a tenant and their tenant misses rent. Their business has a down month. Their kid gets sick and they have to stay home for a week. I mean, the list goes on and on and on.

David Moffatt (09:53):
And what ends up happening is, if you allocate every single extra dollar that you have to paying off your debt, you will have no cash reserves in the event that you need to go and take care of that event. So take a week off of work, pay for the hot water tank, pay for the brake repairs.

David Moffatt (10:16):
Now here’s the interesting part about this is that say, for example, if you owe money on a credit card, if you pay that credit card down, you can certainly use that balance. I don’t know why, but from my experience in watching clients and talking with clients, there’s a big difference in somebody’s spending their cash savings that they worked hard to do and save for than it is, and I guess the behaviour and the feeling is different when they have to add money to their credit card. When people have spent so much time paying down a credit card and then have to bring that credit card back up because of an emergency, they feel defeated. They feel like a failure.

David Moffatt (11:02):
Now, when they spend money out of their cash savings, they feel grateful that they had that savings in place. They feel empowered because they had the money in their account, when in the past, they would’ve had to put that on the debt. So you almost convert a negative into a positive. The net result is almost identical, whether you’re taking out a cash or spending it on the credit card, your net worth is decreased by the exact same amount, a little bit more on the credit card because of the interest cost. Don’t get me wrong. But arguably, if you had to save the money, you’d be paying less on the credit card, meaning that you’d be paying more interest. Anyway, I’m getting a little technical here. It doesn’t really matter. The concept is that by saving money, even while paying off debt, you will actually have a positive emotion in relation to when bad things happen, rather than a negative emotion.

David Moffatt (11:55):
Now time and time again, as I go through this stuff with clients, they talk to me and they say, “Hey, I can’t save any money. Obviously, I’m paying off debt.” And this is completely true, and so this goes back to, how do you know when your debt’s out of control. If you’re struggling, if you can not maintain the payments you’re making, then you probably need to undergo some professional debt restructuring. And again, we’ll get to those options in the second segment of this podcast. But, there’s always a will. There’s always a way. And if that means you have to restructure to decrease your debt payments, to then add money to savings that ultimately what you might have to do.

David Moffatt (12:38):
But here’s the trick to saving money. Most people, what they do is they write out a budget and they say, “Oh, I’ve got $100 leftover at the end of the month.” And then they go and they try to save a hundred dollars at the end of the month.

David Moffatt (12:51):
Well, here’s the thing is that budgets are actually imperfect. And the reason why is because they’re just a good indication of what you want to spend your money on. But again, life happens, which is usually what ends people up in this financial struggle they’re facing.

David Moffatt (13:07):
So here’s what I recommend. What I want you to ask yourself is, how much money if I burned it would not impact my life in any way, shape or form. So for example, if you could pull out a $5 bill right now, and you could burn it, would your life change? For most people, the answer is probably no. That means that you can save effectively $5. I recommend you save it outside of your regular bank and not in cash. So for example, open up an account maybe like Tangerine or Simply Financial or something like that where the accounts are free and then send money there.

David Moffatt (13:51):
Now you just keep going up the list here. If I burned $5, would it matter? If I burned $10, would it matter? $20, $50, $100, $200. You just keep going and what you’ll find is that that number is actually probably lower than what your budget says it is. This is completely okay. The concept behind this is that you are going to be able to commit to saving money, time and time again. if you could burn it and you won’t miss it, that means you can save it and not miss it. And here’s the really, really cool part.

David Moffatt (14:28):
The science behind this is that you’re going to develop the habit of saving. The amount is actually irrelevant. If you even started with a dollar, this process still works. So if you saved money, every single paycheck, and it’ll probably take you about two to three months to properly establish the habit of saving money.

David Moffatt (14:47):
Well, here’s the neat part is that it becomes really easy to turn $5 in to $10, to take $10 and turn it into $20, to take $20 and turn it into $40. I’m sure there’s some science that backs this up, but what I’ve seen is that the time it takes a client to save their first $1000 is the same time that it takes their clients to save an extra $2,000. Meaning they literally double their savings rate compared to their first amount of saving time, if that makes sense. I think this is because saving becomes addicting.

David Moffatt (15:28):
The more and more money you have in a savings account, the more you want to keep that money in that savings account, the more you want to contribute money to that savings account. And even if debt exists, savings will become invaluable to you. It’s a safety net. So this is why we recommend that you save and pay off debt. Mathematically this makes absolutely no sense and probably every financial advisor that’s out there is disagreeing with me right now, especially if they come from a very mathematical background. But behaviourally, you are going to be far more successful.

David Moffatt (16:09):
The next thing to not to do when your debt is out of control is, you should try not to succumb to peer pressure.

David Moffatt (16:21):
This is huge. We live in a society now where it is normal and desirable to keep up with the Jones’s, to have the new car, to go out for suppers, to go to the movies, to have the big birthday parties for your kids, to put your kids in every sport left, right and center. So a little bit of background on me for that, those that don’t know. My long story short is I got myself into a pile of debt, got myself out of a pile of debt, went back to school for finance and ultimately left the military because I spent seven years in the military.

David Moffatt (16:59):
The best word that I ever learned, or sentence rather, is, “Sorry, I can’t. I’m broke.” And you can ask some of my old army buddies, at a certain point in time, any time there would be an invitation to do something, “Sorry, I can’t, I’m broke. Don’t have the money.”

David Moffatt (17:20):
Now here’s a really interesting thing that happened is I thought that people would stop inviting me, that people would stop, I guess, talking to me if that makes sense, which is kind of silly when you think about it, but here’s the cool thing that happened. Everybody was broke. Nobody had any money. And so over time, the activities changed from, “Oh, let’s go out to the big restaurant.”, to “Hey, let’s just have a barbecue in the backyard. We’ll go pick up a pack of hot dogs and hamburgers and do it that way.”

David Moffatt (17:55):
And it’s funny because even to this day, and it actually happened yesterday or the day before, from the time I’m recording this, people still message me. Even though I’ve been out since 2015 now, they still message me and ask me for advice. By the time I left the military, I was saving nearly $800 a month. Now wages in the military are good, don’t get me wrong, but I believe anybody can proportionally do the same thing. You just really have to start with a low amount of money, establish the habit of savings, build that addiction to savings, but in a positive way. And then ultimately that will allow you to save money, tackle your debt faster because now you’re going, “Oh, wow. I want to increase that savings. And if I stopped paying this credit card, wow, this is going to be crazy.” Right. I don’t mean stop paying it as in stop paying. I mean, stop paying it as in, pay it off and then move forward with it. So I hope those four items really help.

David Moffatt (19:04):
We’re going to do a little bit of a sponsor break here. The sponsor of our podcast is actually just going to be us. It’s going to be 4 Pillars. So if you’re struggling with debt and you don’t know what to do, please reach out. We’ve assisted thousands of Canadians understand their debt relief options, and really get ahold of their debt. We promise that when you leave our office, you’ll have a perfect understanding of every single debt relief option and debt restructuring option that exists in Canada. And if we’re not the right solution for you, we will make sure that you go there. We have over 1500 Trustpilot reviews. We have 40 plus Google reviews, just for our local office, many more Facebook reviews. And we want to make sure that you get the best possible outcome, period. We work for you, not your creditors.

David Moffatt (19:52):
So now let’s get back to the Escaping Debt podcast. I think that’s pretty fun.

David Moffatt (19:56):
So the next topic is okay. You’ve identified that your debt is currently out of control. You have self-corrected the things not to do when your debt is out of control. So really what do you do next? Really, this part is when you start considering and looking at your restructuring options.

David Moffatt (20:17):
So what I’m going to do is I’m going to go through the options that exist. And I’m going to give you a high level overview of everything. I’m not going to get too deep into every single option and the reason why is because most of these options, even as simple as budgeting, are so highly specific that without looking at an individual circumstance, it’s very, very difficult to give good sound advice. So I hope you understand that.

David Moffatt (20:47):
Your first debt restructuring option that exists is to try and budget out of your situation. Now, this one seems like common sense. And in fact, most people try it before they come into the office.

David Moffatt (20:58):
This is where you’re going to look at either increasing income, decreasing expenses, to free up more cash, to then pay down debt faster. The rule of thumb here is that if you can pay off your debt in five years or less, you’re good to go.

David Moffatt (21:13):
If you can’t, then you’ll want to talk to a professional and move on to the next step.

David Moffatt (21:18):
The next option is selling assets. Now this involves looking at your assets. So your RSPs or TFSAs, your savings account, maybe equity in your home, any other assets and things that you own that might be worth money and look at selling them to pay off your debt.

David Moffatt (21:39):
This is the worst thing that you can do in my opinion. And I’m actually going to release a podcast on it. So stay tuned for that for all of my opinions and the reason why it is the worst thing that you can do.

David Moffatt (21:50):
But unfortunately, a lot of people do it. They liquidate their pensions, they liquidate their savings. It can make sense in certain instances, but I can tell you, there are not many circumstances where it does. So the next option is to get help from friends and family. This option, isn’t a great option, don’t get me wrong. And most people don’t want to pursue it. But I have had clients where I asked this question, and then they’re like, “yeah, actually my parents said that they’re more than happy to help me out.” And if somebody doesn’t have to go through debt restructuring, that’s a good thing. So the question is always worth the consideration. It’s always worth the ask.

David Moffatt (22:31):
The fourth option is to go to the bank and try to get a consolidation loan. Now, this consolidation loan can be in the form of an unsecured loan, a line of credit or a personal loan, or it can be in the form of a mortgage. I’m going to talk about both of these. I’m very hesitant to recommend consolidating in this manner, unless it really makes sense. And the reason why is because we’ve seen, and you may personally be in this situation, you go and get a consolidation loan, or regular personal loan to consolidate your debts and then you didn’t really solve the problem. And the next thing you realize a year or two years later, you’re right back up to the same debt load you were plus you now have a big consolidation loan. Or you go and get a line of credit to decrease your monthly payments, which is fantastic, but you realize, “Oh crap, I can only afford my minimum interest payment, which means my debt isn’t decreasing.”, which means you’ve just handcuffed yourself for the rest of your life.

David Moffatt (23:35):
So that’s my concern with regular consolidating. To be clear, though, it can make a lot of sense. So for example, I’ve had individuals that have, say they took it alone five years ago, they paid it off three years. They had to change in income, their loan payment just simply doesn’t work based on their new position. So they may want to go and refinance that loan into a three or four year loan payment to then pay it off. It’s not a perfect example, but it is an example of where it can make sense.

David Moffatt (24:12):
In terms of mortgage refinancing. I highly recommend talking to an unbiased professional when you do this. And what I mean by an unbiased professional is, I mean, somebody that is not selling you the mortgage. The reason for this is because unlike an unsecured debt, if you stop paying a secured debt, you lose or at least risk losing, whatever asset is being used as collateral, for example, for a car loan, that would be the car, but for a mortgage that is your house. So by refinancing into your house, you are risking your house. So it’s not to say that this isn’t a good idea. In fact, if it makes sense, it’s probably one of the best forms of restructuring, just because of the fact that it usually brings you your lowest monthly payment, but you’re now amortizing your debt now over 20, 25 years or however long it can be. There’s also only applies if you have a house, which I think is statistically 40% of Nova Scotia or something along those lines, I don’t have those exact stats on me.

David Moffatt (25:23):
So those were the first four options. So budgeting, selling assets, getting help from friends or family or a consolidation loan, whether it’s unsecured or secured. Those four options are the only options that won’t impact credit. Anything past this point will impact credit. And I actually have a, the next episode that we’re going to be releasing, or maybe the one before this, it just depends on when they come out, talks about why it shouldn’t matter that your credit gets impacted if you need to restructure. And the truth of the matter is, if the first four options do not work for you and you have a debt problem, you realistically should be considering restructuring.

David Moffatt (26:03):
So the first option is credit counselling. So credit counselling is essentially where a credit counselling firm takes a hundred percent of your debt load. They amortize it. Now over typically four to five years, you pay a fee, which depending on the firm ranges, typically from five to 15% of your overall debt load, and you pay it out, typically at an interest rate of around 5%. When you look at the math, in terms of more invasive forms of restructuring, this is actually the most expensive option that exists in the market for most people. It can make sense for smaller debt loads, but once you start getting up there, there are usually far better options.

David Moffatt (26:50):
The problem with this option is, you end up paying all of your debt plus some, and it impacts your credit. So it’s quite strange that you pay back everything yet your credit gets impacted. Really at the end of the day, no differently than a proposal of bankruptcy or informal settlements. And that’s a good note to make, is that really from a real world impact day one, that you do any type of restructuring, including bankruptcy, your credit is going to be impacted the same, no matter the option. The real difference is how fast you can re-establish after the fact and how much you pay on a monthly basis, which also impacts how fast you can re-establish your credit.

David Moffatt (27:30):
So after that, you can look at what’s called an informal settlement or an informal proposal. This is essentially where you accumulate a lump sum of money and you make an offer to your creditors for a percentage of how much you owe. So if that is a $20,000 and you have an $8,000 lump sum, you may offer $8,000 in lieu of paying back that entire 20,000. This option can make sense if you have lump sums of money. In my experience though, most people don’t and so it isn’t really that great of an option for most people. When it is an option, though, it is usually a very, very, very good option.

David Moffatt (28:14):
After that you have a consumer proposal, which is an option whereby you pay more than you would in bankruptcy, but less than you owe and you come to an agreement with your creditors. These are filed through licensed insolvency trustees, and I’ll probably end up having a podcast on those, on how consumer proposals and bankruptcies work. And I also have companion articles for those, which you can go check out at the blog. Consumer proposal is arguably one of the most effective ways to deal with debt, because in most instances, it is actually the cheapest monthly payment that you will obtain in most instances, not always, of course, but in most. And it comes with very, very limited consequences on a long term basis when you compare it against bankruptcy.

David Moffatt (29:04):
Essentially how it works is it’s a five year payment at 0% interest. There’s no penalties to pay it off early. And if you paid off early, your credit is restored quicker. The credit impact is for maximum of six years or three years past the date of the last payment. Meaning if you pay it off early, it’s better for you. The next option after this is a bankruptcy, of course, a bankruptcy is, in our opinion, a last resort option. It comes with the harshest penalties. And for a lot of people, bankruptcy is actually the most expensive option. And the reason why is because it’s based upon a calculation that takes into account how much money you make and how much things you own.

David Moffatt (29:47):
So if you own anything that has equity in it, and for example, a house that has equity, or if you have a TFSA or an RESP or anything of that nature, bankruptcies can actually be extremely expensive. Now bankruptcy is an option for some people, but for example, in our office, we see, I believe the stats that I last polled are less than 3% of our clients really opt to file bankruptcy when they truly understand the pros and the cons of all these other options that we’ve talked about.

David Moffatt (30:18):
Bankruptcy is worse than the more times you do it, which means that a first time bankruptcy is bad enough, but it’s not that bad. But if you have to go bankrupt a second, third or fourth time, which going bankrupt a second time is statistically fairly high, it will be devastating, not just emotionally, which of course it will be, but also financially as well.

David Moffatt (30:46):
So everybody, I hope that makes sense. So to kind of recap, in this episode, we discussed what not to do when your debt is out of control and what options exist when your dad is out of control. We always recommend that you speak with a financial professional to really cover these options as they pertain to your financial situation. No two situations are alike. And so I highly discourage you from listening to your friends and relatives that may have done some of these options, because I don’t know how many times I have to dispel myths. We covered, more importantly in my opinion, what not to do. And so make sure that you’re just very conscious of your financial situation. Remember the more attention that you give to your finances, the better outcome you’ll have.

David Moffatt (31:43):
Anyway, I hope that was helpful for you. Again, my name is David Moffatt, I’m the host of the Escaping Debt podcast. Remember that our goal is that no consumer should have to struggle with the burden that debt causes and we believe it is simply not possible for a company to represent both the consumer and the creditors at the same time in an unbiased fashion. And because of this, we work for you, not your creditors. Have a great day.