Save or Pay down Debt | Manulife Retirement

Transcript

Hello, and welcome.

In this webinar, we’re going to take a look at that age-old question: Should you save or pay down debt or both? We'll look at:

What do we mean by saving? What do we mean by paying down debt?
How interest rates can affect both your savings and your debt.
What you need to think about when deciding to save or pay down debt
Strategies to help you decide

With every webinar in our series, we ask for topics people want to hear about. This one comes up a lot.

Is it better to save or to pay down debt?

This question comes up again and again as we make bigger, more important financial decisions in our lives. If you’re still not sure of the answer, don’t feel alone! A lot of Canadians are trying to figure out what’s best for the future of their money; both choices come with pros and cons. So naturally, opinions are all over the map.

The truth is, there’s not one right answer because everyone’s money situation is different. While some of us carry a lot of debt from buying cars, vacation packages, or investment pieces for our shoe collections, others don’t. Same goes for saving: Some of us have emergency funds and retirement investments, others have a pickle jar of change on the dresser. But at some point, in the interest of our own financial well-being, we all have to take a look at where we’ve been and decide what to do next.

That’s why you’re here—for tips and strategies that make it a little easier to decide which is right for you: saving or paying down your debt or maybe a little of both.

Okay, so here are 4 reasons why you may want to think about paying down debt first:

1 Debt’s never free—When you borrow money, you pay interest, and interest costs can really add up, especially when we pay only the minimum on credit cards. In fact, if you borrowed $5,000 on a card at 15% interest and paid a minimum of 2%, by the time your card was paid, off you’d have paid $7,789.37 of interest! And you’d have been making payments for more than 30 years.

2 The sooner you pay off your debt, the sooner you can invest your payments—Let’s say you’ve got a car loan that costs you around $552 a month. The sooner you pay that off, the sooner you can invest that money instead. If you earned 7% on it, after 30 years, you’d have $670,000! That’d be a pretty nice nest egg if you weren't stuck paying off a car, a car that, when you’re done, isn’t even close to being worth what you paid for it. And we won’t even get into the money you’d lose by taking on more debt for car insurance, gas, or maintenance.

3 Debt makes it harder to borrow when you really need it— Sometimes, borrowing money is actually good for us. Yes, you heard me right. For example, if you have to borrow money to grow a business or pay for college, it may help you earn more in the long run, and most people need to borrow to buy a home. Investing in the right house, in the right location, at the right time, can often mean big returns! But if you already have a lot of debt, your bank might not approve a loan, even a loan that could help you with a worthy goal.

Most lenders look at how much debt you have versus how much money you make; we'll look closer at this on the next slide. If you already have all the debt they think you can afford, they won’t lend to you. Or if they do, they’ll charge you higher interest. If you pay down your debt, most lenders see you as a less risky borrower, which helps you get loans on good terms when you really need them.

Last but not least:

4 Your debt stresses you out—Is your debt keeping you up at night? If it is, you may want to start by paying it down. Your mental well-being is important too. You can save when that weight is off your shoulders.

Let’s take a moment to look a little closer at how banks and other lenders decide whether to approve a loan.

According to the Canada Mortgage and Housing Corporation (you may have heard them called CMHC), mortgage lenders use 2 main calcultions—in this case, they’re ratios—to decide if borrowers can afford to buy a home:

1 Gross debt service—GDS—is the percentage of your monthly household income that covers your housing costs. It should be at or under 35%.

2 Total debt service—or TDS—is the percentage of your monthly household income that covers your housing costs and any other debts. It should be at or under 42%.

If your ratios are higher, you may want to lower them before you buy. You could save more for your down payment, pay off some debts, or both.

But the GDS and TDS standards are guidelines, not rules. If you have other valuable property, or you’ve kept up well with paying your past debts, they may still approve you.

Here are 4 reasons why you may want to think about saving first:

1 You don’t have an emergency fund—If you don’t have much in the way of debt, but you also don't have any extra money saved, try setting aside a small amount every pay so you won’t have to go into debt if you lose your job or find yourself with urgent home or car repairs. We actually offer a webinar all about starting up an emergency fund. Visit manulife.ca/webinars to sign up.

2 You have a savings program through work, and they match the money you put in it—Don’t pass that up. Not only are you saving, you’re earning extra money from your company, as well as the money you make on that money while it's invested. Let’s say your company matches half of every dollar you put in, up to 5% of your salary. You make $50,000 and put in the full 5%, or $2,500, of your own money. Your company then chips in half of that. That’s awesome! You’ve just made $1,250 plus whatever you earn over the years it’s invested! And the sooner you save, the longer it’ll be invested; the longer it’s invested, the more it could earn. The more it earns, the less you have to save to reach your goals.

3 You might get more by investing than you pay in interest—If you're lucky enough to have debt with a low interest rate, it might make sense to save instead of paying it down. The rate of return you get on your savings may be higher than the interest you pay on your debt. The difference is money in your pocket!

And finally:

4 Your debt doesn’t worry you—How much debt are you comfortable with? Maybe you already got your debt sorted into one easy payment at a lower interest rate, or you’re okay with the debt you have: You still have plenty of money to pay your bills and do the things that are important to you, and you’re confident you’ll pay it off within the next 5 years.

How’re you feeling so far? Talking about debt can be stressful.

Some of us want to get out of debt at all costs, but we worry: What if something happens and we haven’t saved money to cover it?

Or ...

Sometimes we know we’re paying more interest than we should, but having money saved gives us peace of mind. Let’s be honest, if having a certain amount of money saved makes you feel safe, you’re not likely to do anything big to change it.

But big things happen when we start little!

Is it better to save or pay down debt? It’s not always easy to pick one over the other. For you, the best answer might be to do both. But think little! Save and pay down a little debt. Or save less and pay down a little more debt.

If you find yourself with a bit of extra money after all your bills are paid (hurray!), why not put half towards your debt and the other towards your savings, retirement, emergency fund, whatever feels right. Or maybe put three-quarters of it towards your debt and save a quarter of it. Or vice versa. You know what you need for your peace of mind and your future goals.

Now, let’s see what these tips look like in action.

Meet the Johnson family: Anne, William, and their two kids

Like a lot of us, they have a mortgage, a car loan, and some credit card debt. They are concerned about their debt, especially with the cost of living taking a larger chunk of their monthly cash flow.

Both Anne and William save a little for retirement through their workplace savings programs. Both put money in their TFSAs, but neither puts in the maximum amount and, together, they put money into a family RESP for the kids’ education, which is great, because the RESP grows more with grant money from the government.

Let’s take a closer look:

Their mortgage just renewed for 5 years, and they are concerned about the higher payments.
Their car has two more years of payments.
They have a small amount in other personal debt.
They’re proud to be saving for their kids’ education.
But they’re a little nervous that they have no extra money saved just in case.
And they would like to retire in 12 years.

So what’s their plan?

With the Johnsons, it probably makes sense to save and pay down their debt.
First, they should focus on reducing their other consumer debt, paying off their credit card. They are comfortable with the car payment as there are only 2 years remaining at a lower rate.
They will then focus on building an emergency fund so they do not accumulate any future debt if something happens, providing them a financial cushion.
And of course, we can’t forget about retiring in 12 years! If they put off saving until their debt's gone, it may be too late. The longer they wait to start saving, the more they have to save to reach their retirement goal. They could put more in their workplace savings programs, especially since both their companies match some of what they put in.
Once they’ve got more money going to their retirement savings, then they can put the focus on paying down their mortgage using prepayment privileges such as lump-sum payments.

Now let’s meet Carl

Carl’s 23 and just graduated university. He’s got a student loan, but no mortgage or car payments. He works part time so he can use the rest of his time to focus on his music. To cover some of his living expenses and his guitar collection, he’s got some credit card debt and recently took a personal loan. He’s got a few extra dollars in his chequing account, but he hasn’t really started paying down his debt yet.

Let’s take a closer look:

Carl’s student loan debt totals $30,000.
His personal loan is for $5,000, and he’s got about $12,000 on his credit card.
He rents an apartment with a friend.
He takes public transportation and doesn’t have to pay for a car.
He expects to make it big in the music biz and retire off the royalties.

Nice to have a dream, isn’t it? But really, he’s starting to warm up to the idea of a backup plan. But what’s it going to be?

This one’s a little tricky. If Carl can get a low interest rate on his student loan, and if the interest he pays lowers his income tax each year, it’d be a good idea to focus on his high-interest credit card debt first, followed by his personal loan. He might want to look into putting all his debt together for a lower overall interest rate and one comfortable monthly payment.
A full-time job would give him the money to pay down his debt faster. I know music’s his passion, but where there’s a will, there’s a way, right? Carl’s still pretty young, so he’s got time on his side, but he shouldn’t put off saving for too long.

And finally, let’s meet Janice

Janice is 55. She bought herself a farmhouse years ago and spent evenings, weekends—and a few extra dollars—making it her own. She’s been working at the same job for the last 10 years. She puts money in a retirement plan through work, and her employer makes contributions as well. Overall, she’s feeling good about how far she’s come, but she’s starting to think about what comes next, and wants to be sure she’s ready.

Let’s take a closer look:

Janice still has $100,000 left on her mortgage at a rate and payment she is comfortable with.
She has a balance of $12,000 on a car loan but no personal or credit card debt.
She’s thinking she’d like to retire in about 5 to 10 years.

Janice needs to save money and focus her efforts on her retirement plan.

First, she needs a budget. This way, she can figure out how much money she has to work with once her living expenses and bills are paid.
Janice should look into her government benefit programs to assist in determining her monthly cash flow once in retirement
Next, Janice should find out how to maximize her group savings program at work to make sure she’s taking full advantage of her company contributions.
Then, with whatever she has left, she can make some decisions about other investment opportunities such as a voluntary plan (RRSP in group plan or TFSA). A TFSA would allow her to have a component of her retirement savings and/or emergency fund tax free.
Once that’s done, she can decide if she wants to put that money on her car loan or mortgage.

Thinking about the Johnsons, Carl, and Janice probably gets you wondering about your own situation and feelings. Good! Because you need to start thinking about what’s right for YOU.

It comes down to this: We all have different priorities. Get to know yours.

Maybe it’s HAVE NO DEBT—Some of you may believe there’s no amount of debt that’s okay. You’d much rather have the peace of mind that comes from being debt free, and that’s fine. That’s what you’re comfortable with. It’s what works for you.
Maybe it’s HAVE MONEY SET ASIDE—Sure you have debt, but it’s old debt at a low interest rate. Maybe it’s a student loan and the interest payments lower your income tax. Your payments are totally comfortable. You’re in no rush to pay it down.
Maybe it’s PAY LESS INTEREST—Some of you may have high-interest credit cards, with balances you’d rather not mention. You might want to pay them off with every extra cent you can find.
Maybe it’s MAKE MORE MONEY—You’ve got the money to buy a car with cash, but you think buying it with a low-interest loan makes more sense for you. So you can invest the money instead, put it to work building up your savings since you want to stop working before long.

It all depends on the type of debt you have, how long it‘ll take to pay off, and if you can put off saving until you’re debt free.

It also depends on what feels right for you, so be honest with yourself.

If you decide to pay down your debt first, and you have more than just one debt to pay, you have another decision to make. There are two main theories for paying debt.

1 Pay off the debt with the highest interest first, regardless of the amount. Then on to the one with the next highest interest, and so on.

2 Pay off the debt with the lowest amount first, regardless of the interest. Then on to the one with the next lowest balance, and so on.

Both ways have their strengths and weaknesses.

Paying off the debt with the highest interest first means you get rid of the debt that is costing you the most as quickly as possible, which lowers the total interest you pay in the end. But it can mean a slow start. With each payment, a good chunk of your money’s paying the interest instead of the amount owed, and if the amount is high, it’ll take a while to feel like you’ve made a difference, which can be discouraging.

Paying off the debt with the lowest balance (or amount) first means your first debt is gone pretty quick, which feels great! That emotional boost keeps you motivated, and the memory of it can keep you going through the bigger debts later on. But it can mean the total interest you pay in the end is higher, particularly if the debts you’re leaving ‘til the end have high interest.

A minute ago we talked about knowing your priorities. This decision is really about knowing yourself.

If you know you can keep going even during a slow start, pay off the debt with the highest interest first. Financially, you can’t beat paying less interest overall.

On the other hand, you may need that emotional boost. There’s nothing wrong with that. Pay off the debt with the lowest amount first. You’re more likely to see it through if you start small—it can be less overwhelming—which means less interest than if you lose hope and give up! If you really want to start with the high interest debts, make sure you prepare strategies that’ll keep you focused when you feel discouraged.

We’re getting to the end of our session! There’s a lot to think about. Save or pay down debt? You all have the same question, but I can’t give you all the same answer.

To answer it yourself, here are some next steps to consider.

First, make two lists. The first is a list of all your debt, including the amount and the interest rate. The second will list your savings goals or priorities.
Next, compare the investment return you could get on your savings versus the interest rate on your debt. Can you get more by investing than you would pay in interest?
- If the answer is no, pay down your debt.
- If the answer is yes, save. Also, think about moving your investments or your debt to make the most of it; for example, move the money you owe from a credit card at 19% (or higher) to a secured line of credit at 6% to 7%.
- Of course, you’ll also need to consider how you feel about debt. If worrying about debt is keeping you awake at night, paying down your debt is probably the right move for you. Paying down debt is a risk free way to get your money to a better place.
Finally, like most decisions we make about our money, speaking with a licensed financial advisor can make all the difference. Financial advisors will help you make sense of all the numbers and then help you fit them in with how you live and how you want to live.

Thank you again for joining us, we hope you join us again soon!