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The Globe and Mail

Avoid hitting your own personal debt ceiling

The U.S. government's recent resolution to raise the debt ceiling averted a financial crisis, but there are chilling similarities between how both Washington and individual Canadians are struggling to manage their debt.

Like the U.S. government, many Canadians owe more debt than their income. In addition, not many have set aside money for a rainy-day fund, says Janet Peddigrew, vice-president with Bank of Montreal in Kitchener-Waterloo.

"Too many people are living paycheque to paycheque. If there was an emergency, such as losing their job, they would have to turn to credit cards and line of credit … incurring further debt at a time when they are not able to repay it. It becomes a vicious cycle."

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A report released last month showed that the rate at which Canadians are borrowing money for consumer goods has slowed dramatically. But a steep run-up in housing prices means many people are now saddled with large mortgages.

Ms. Peddigrew says it is tempting to use credit for things like shopping or going to see a show, something previous generations would never do.

"Today we live in a culture where it seems like more of a norm to have credit cards, a mortgage and lines of credit, which is good and gives us flexibility. But we need to make sure we take the time to manage what credit is available."

When it comes to their personal financial health, Ms. Peddigrew has provided these tips to help Canadians avoid hitting their own personal debt ceiling:

1) Don't spend more than you earn. The U.S. government carries six times in debt what it makes in revenue. The average debt-to-income ratio for Canadians shows we owe $1.47 for every dollar we earn. Everyday expenses are one of the biggest reasons we're not saving. Be mindful of your spending habits. For example, instead of splurging on takeout, eat in and put that money into a high-interest savings account.

2) Shed high-interest debt. Consolidate credit card debt with a line of credit or one low-interest card. Whenever possible, target high-interest debt and pay off your entire credit card balance every month. The faster you pay off the balance, the less interest you'll pay.

3) Stress-test your housing budget. Buying a home is likely the largest debt you will incur. Before you buy, do the math and make sure you can afford it. A good rule of thumb is that your total housing costs should not consume more than one-third of your household income. Sit down and plan all of your house-related expenses – everything from heating, cooling and lighting costs to property taxes, insurance and mortgage payments.

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4) Reduce your debt time-horizon. The shorter the life of the mortgage, the less you pay in interest. Choosing a 25-year amortization can help you become mortgage-free faster and, ultimately, put more savings towards long-term goals, such as retirement. Also consider taking advantage of annual prepayment privileges to pay down the principal.

5) Save for a rainy day. More than 40 per cent of Canadians will not be able to handle their financial obligations in the event of an emergency, a recent survey by Leger Marketing shows. Having a contingency plan in place doesn't have to mean living on a shoestring budget. Putting away $25 a week can add up to $1,300 over a year's time.

6) Invest what you save. Consider a Tax-Free Savings Account (TFSA) or high-interest savings accounts for whatever you manage to set aside. Be sure to do your homework on which institutions offer the best rates, as well as on the details of each type of account, including withdrawal and contribution rules for TFSAs. Explore your options on what works best for you.

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