November is Financial Literacy Month in Canada. Check out the final part of our #FLM2019 blog series below:
My parents were depression babies and lived a frugal lifestyle. Their philosophy was simple – one should never borrow money to buy things, with the possible exception of a mortgage for a home. Any other type of borrowing was to be avoided at all costs. Cars were purchased with savings – not loans. Money was saved and these savings were used for things like clothing, household items and vacations. They lived within their means and if they didn’t have the money saved, they didn’t make the purchase until they did.
I remember when they got their first credit card in the 1970s. My father’s employer owned a large Canadian retailer and to get a staff discount, purchases had to be made using the card. This was their introduction to the world of unsecured credit.
Oh, how times have changed!
Today, the average Canadian owes $1.78 for every $1.00 of income. Whether it is for necessity or convenience, Canadians appear to be very comfortable borrowing money. But are they borrowing money wisely?
As opposed to my parent’s day, borrowing money for purchases seems to be a norm today. Who has the ability to plop down $25-50,000 for a new car from their savings or simply write a cheque for their kid’s education? In today’s society, we are also bombarded by offers of credit to assist with purchases like “buy now and pay later” deals, “no interest and no payments for 6 months”, and cashback or travel points on your credit card purchases.
While credit can be a helpful tool for achieving life goals like going to university, buying a house or a car, it can easily get out of hand. I meet with people each and every day who are no longer able to meet their financial obligations. The availability and misuse of credit is a large contributing factor for many of those individuals.
Is it possible to live today without borrowing money? If you have the ability to live using savings and cash only, kudos to you. For the rest of us, however, some borrowing is required.
A big part of borrowing wisely is figuring out if what you are borrowing for is a good investment. Borrowing money for items that appreciate or increase their value over time are normally considered good decisions. Getting a mortgage to buy a home or a loan for your education, or your child’s education would be considered a wise borrowing decision. Taking out a loan or using credit for larger ticket items that have values that depreciate over time, like vehicles and large appliances, is less desirable but often necessary.
If you are borrowing money for everyday purchases like groceries, gasoline or to pay vacations, this could be a poor use of credit. If you get extra cashback or points from these types of purchases, it’s okay to use credit as long as you have the funds available or a plan in place to pay the balance off in full at the end of each month. If you can’t pay it off in full monthly and only pay the minimum payment, bad financial habits will form and you’ll end up paying more in interest.
If you, like most Canadians, rely on borrowing money, the following tips can help ensure you are borrowing wisely:
- Try to limit your borrowing as much as possible. Credit does not increase your income but rather the interest costs will decrease your monthly cash flow in the future.
- Before you make a purchase on a credit card ensure your monthly budget can absorb the payment next month when the credit card bill arrives. If you can’t afford the purchase today are you sure you can afford it tomorrow?
- When purchasing a large item such as a home or a vehicle, ensure that you are budgeting for the additional costs associated with the asset such as heat, power, insurance, gasoline, repairs and upkeep, not just the loan payment.
- Shop around for the best interest rate on loans and be aware of how much interest you will pay over the life of the loan. Try to commit to as short a term as possible to limit the effects of compounded interest charges.
- Do a needs and wants assessment before borrowing money. Do you really need the item or merely want it? And always purchase wants with savings, not credit.
- Borrow only what you are comfortable committing to. If you are pre-approved for a mortgage or car loan remember this is the maximum amount you can borrow but not the amount you must borrow. Don’t let anyone talk you into borrowing more than you can comfortably afford.
Credit and loans are available everywhere you turn today and it’s up to you to decide whether to borrow or not. Most likely you will need to borrow at some point. When you do, remember to take the time to research the options available to you. Borrowing wisely not only means figuring out the loan or line of credit that best fits your needs but also your lifestyle.