While many experts are now calling for a soft landing in Canada instead of a recession, we aren’t out of the woods yet. The Consumer Price Index (CPI), which measures inflation and the change in prices for consumer goods, is rising. In fact, it increased 8.5% in July, following a 9.1% increase in June, according to Statistics Canada.
That means that without wages rising at the same rate (which they aren’t), it’s getting more costly for Canadians to afford everyday items, like groceries, clothing and gasoline. This could cause many people to use their credit cards, or take out a loan just to make ends meet.
Remember that debt isn’t bad. Using credit responsibly can actually help you increase your credit score. Read our blog on what to know about credit utilization to learn more.
But if you overextend yourself, it can cause you to miss payments or make it difficult for you to pay even the minimum payment because you simply don’t have the funds. And that hurts your credit score (more on that below). So read on to learn about three debt traps to avoid, as well as some tips so you don’t find yourself in a dire situation.
1. Abusing credit cards
Having a credit card is pretty much necessary as an adult. A credit card helps you build a healthy credit score, which is used by lenders to determine whether you get approved for a loan or mortgage, and at what interest rate. The higher your score, the less risky you seem as a borrower to a lender.
Building a healthy credit score may seem easy. But it’s not that simple. You use your credit card, and pay at least the minimum payment each month. If you overextend yourself each month by continuing to use your credit card for everyday items, that debt can rack up, causing you to miss payments. Further, if your balance keeps growing and you’re only making the minimum payments, you may also be hurting your credit because your credit utilization rate has risen.
The solution? TransUnion suggests ideally keeping each of your credit cards’ balances below 35% of your available credit. So if your limit is $1,000, then keep your outstanding balance below $350, notes the credit reporting agency on its website. The key is to monitor your outstanding balance so that it doesn’t go above the 35% suggested limit, and ensure you pay off at least the minimum each month.
2. Spending more than you can afford
It may seem obvious for people to spend less than they earn each month so that they have some money left over for savings, but it isn’t always possible. Life happens. A last minute getaway with friends? Sure. Your child wants to sign up for hockey, which has an average cost of $5,000 per year, according to FlipGive and Scotiabank? Sure. Even something that seems nominal at the time, like you get the flu and decide to order out food for several days because you’re too tired to cook, can add up during that month. Further, any additional costs can even be carried forward and grow exponentially if not paid off right away, thanks to interest.
Whatever the expenditure is, it can impact your financial situation and cause your debt load to mount. That’s why having a cash flow plan is so important. A cash flow plan is a thorough evaluation of your spending, debt and income. It uses strategies to help you stay on track to meet your short- and long-term goals. For instance, your short- or long-term goals could include an annual vacation, saving for a wedding, home renovations, as well as retirement. Working with a seasoned professional, like a Certified Cash Flow Specialist (CCS), is one of the ways you can create a cash flow plan to meet your goals.
3. Not having an emergency fund
It’s wise to have a financial cushion that you can fall back on. Imagine losing your job, or having a large financial purchase come up, like a home repair or medical bill. These types of emergencies can cause you to go straight to your credit card or the bank for a loan. But you shouldn’t have to. That’s why building an emergency fund is so important, and it takes time and planning. Manulife recommends having at least 3-6 months' worth of expenses saved in an emergency fund, just in case.
So set aside some money each month to put towards this fund. How can you do that? Look at your monthly income and expenses, and figure out where you might be able to cut back.
And automating that extra money can help, even if it’s small. Say you automatically have $100 each month transferred towards that fund. In one year, that’s $1,200. And that’s not including any accrued interest on the account. For instance, a high-interest savings account (HISA) can typically offer an interest rate from 1% to 3%.
In two years, that $100 per month is $2,400 (not including the accrued interest on the savings account). Whatever amount makes sense for you, put it away, forget about it and watch it build.
Again, working with a CCS is a great first step. A CCS can help you figure out your income, monthly expenses, and how much you have left over each month, which can be put towards this fund.
As inflation and the CPI continue to rise, taking steps towards building your savings, and managing your debt is key. Avoid overextending yourself when it comes to using your credit cards, and be sure to stick to your cash flow plan so you avoid getting yourself stuck in a debt trap.
CacheFlo is a financial education company that builds eLearning and tools to help financial professionals and individuals make behaviour-based changes, which allows them to get more life from their money. We want to make it easier for people to predict the impact of their financial choices before they make them.
About the Certified Cash Flow Specialist (CCS) program
CCS professionals go through enhanced cash flow-based training to develop the skill set to deliver behaviour-based cash flow advice. They start the financial planning process with a cash flow plan to genuinely help their clients get more life from their money.
About the Real Life Money program
An annual, digital, behaviour-based program that teaches employees everything they need to know and do to become financially capable. Our proven financial wellness program combines online workshops, microlearning, and a powerful app called Winton that puts financial capability, confidence and control into the hands of every employee. Learn more.