Interest and Debt Repayment

In terms of repaying debt we often lose sight of that fact that we are actually building our wealth. The interest charges on our loans and credit cards can significantly increase our debt load in the same way that interest gained on investments can accelerate our wealth.

The Power of Interest and Debt Repayment

Many believe that paying off debt comes before investing and that building wealth and paying off debt shouldn’t occur simultaneously, but the fact is that the two tasks are absolutely compatible! For every single dollar you pay toward your debt, you are indeed increasing your net worth by that same dollar amount and even more.

How does that work? Because for every dollar of debt you pay off, the amount of interest you pay to the bank/creditor goes down, and that means more money in your own pocket.

Let’s use an example. Suppose you have a net worth of $100,000, but you also have outstanding loans. Your goal is to save $500 a month and put these extra funds towards this loan. In as little as six months you paid off $3,000 of your debt and your current net worth is $103,000, a gain equal to the amount of debt you’ve paid off. That’s an increase in net worth of roughly 3%.

The bonus is as you continue to pay down your debt, your net worth continues to increase, you pay less interest to your creditor and debt reduction really begins to ramp up (in the same way growth builds in your investments).

A Warning About Revolving Debt

Debt that is continually revolving, as in credit card debt, has serious implications for debt elimination.

Credit card debt and cash advances have very high interest rates, and just like your investments, the higher the interest rate and amount owing the faster that debt will grow. Credit cards are not recommended for debt that will take a long time to retire.

Credit options, like loans where the rates and monthly payments are fixed, are more effective because these parameters help mitigate the consequences of compounding issues.

What Happens When You Can't Pay Debt?

In situations where an individual has incurred a significant amount of debt, there are some measures that need to be taken: bankruptcy and consumer proposals. Understanding what these processes are will help you make wise choices and avoid having to go through these processes as a result of debt.

Bankruptcy: A legal process that can provide relief to individuals who are unable to pay their debts.

Consumer proposals: A legal process similar to bankruptcy except they help a personal pay off debt through settlement agreements.

For more information on settling your debts, finding a Licensed Insolvency Trustee or accessing bankruptcy records, visit the Government of Canada's Bankruptcy website.

Need More Information? 

If you want to learn more or get more resources on how you can manage your money, book an appointment with a financial coach.