There’s an old-school way of thinking that says debt – any kind of debt - is a bad thing. The truth is, without debt most of us would be living in huts on roads of mud. But debt remains a constant reminder that you are personally beholden to someone or something, and are never truly free as long as you are bound by debt.
Four things are needed to effectively tackle debt: income, a plan, discipline and some luck. With the first three in place, the fourth came my way in the wake of the 2009 global financial meltdown.
Prior to that historic event we had been paying about five per cent on our fixed-rate mortgage since 2002. It was a big mortgage for us and the bulk of the payments were interest, while the rest would nibble away at the principal for the next 21 years (2023).
As global markets tumbled in late 2008 central banks slashed rates to keep the financial system from freezing. I still have a 2009 letter from the bank informing me my mortgage had dropped to 1.5 per cent.
We never paid more than three per cent from that point, but continued to make the same regular payments until just last Friday when the magical day came and we were debt free – six years ahead of schedule.
Debt situations are differ from person to person but there are a few timeless lessons on the power of compounding we can all relate to:
- It’s always a good time to pay down debt: People only seem to get serious about debt when rates are high. Paying down debt when rates are low reduces the principal more aggressively, but it also prevents that same principal from generating gobs of interest when rates are eventually high.
- Use online mortgage calculators to illustrate savings: Many financial institutions provide calculators that enable you to enter a payment amount and see how much you save in dollars, along with how much it would shorten your amortization period. Could you ever get a risk-free return like that from any other investment?
- Don’t use your home equity as a cash machine: Only use home equity lines of credit (HELOCs) to consolidate high interest debt, for emergencies or in retirement. They also come in handy to make registered retirement savings plan (RRSP) contributions provided the tax refund is used to pay off the debt.
Don’t be taken in by all the home equity lenders out there who tell you it’s okay to use your house as a cash machine.