21 – Differences Between Good Debt and Bad Debt

Wayne Kay  0:04  

Welcome to the Debt Matters podcast. We help Canadians here find solutions to the debt with Licensed Insolvency Trustees from across Canada. I’m Wayne Kay. And in today’s show, we’re going to talk about good debt versus bad debt. 

Joining me I’ve got Derek Chase from Derek Chase & Associates, Licensed Insolvency Trustees in Campbell River. Derek, thanks for being here today.

Derek Chase  0:25  

It’s my pleasure, Wayne, thanks for having me.

Wayne Kay  0:27  

I love talking about debt – because some debt is good, some debt is bad. And we’re going to find out all the differences today on the show. So I’m looking forward to it. Debt is not always a bad thing is it?

Derek Chase  0:41  

No, that’s just a part of life. Sometimes when you’re making a significant purchase, it can be necessary and just part of regular life. There’s no doubt about it.

Wayne Kay  0:52  

I remember talking with a guy I know. He started a trucking company years ago. And I mentioned something about debt. And he said, Oh, I live in debt, but I use it to grow my business. So that would be, I guess, obviously, a good debt. So when we talk about good debt, what are we talking about?

Derek Chase  1:11  

Well, I think along these lines. Good debt gives you ability to do things that are, in the long run, going to be good – in the sense that you’re growing your company, or maybe you are acquiring a house to live in or some tangible asset that’s going to benefit your life –  and you can’t afford it without going to the bank or some lender and borrowing,

Wayne Kay  1:39  

Right. Because there’s nobody’s going to be able to just save up enough to go buy a house these days,

Derek Chase  1:44  

No, most of us  – to buy a house without the use of a mortgage, it’s just not practical. But no, even if you’re acquiring something that’s good, like growing your business or acquiring a piece of real estate – that loan still needs to be good – in the sense that the interest rate that you’re paying is acceptable to you. 

A good debt definitely has low or modest interest rates. A good debt can quickly become a bad debt, if you are doing something with an asset that’s going to be good for your life – but the interest rate on that debt becomes exorbitant, just too high. And then almost like a loan shark type situation, and that pushes that debt from good to bad, in my opinion.

Wayne Kay  2:33  

Alright, so let’s do the shift to bad debt. What does bad debt look like?

Derek Chase  2:38  

Firstly, bad debt has high interest rates, in my opinion. We see interest rates on debts range anywhere from 3% to 33%. So it’s a wide range. And if you end up in a high interest rate loan, 28% on your interest rate, you’re just never going to pay that back. You’re paying such huge amounts of interest. It makes it just a very bad situation. 

In conjunction with that, if I put on my accountant hat, any debt, the interest expense on it is either deductible on your tax return or, or non deductible. And certainly bad debt has non deductible interest, so you aren’t able to get a bit of a tax benefit from it.

Wayne Kay  3:26  

So what would be the debts you can get tax credit from?

Derek Chase  3:30  

Well, certainly any debt that you’re using to earn business income is deductible. When you borrow to make an investment, say in some sort of stock products, some sort of investments, that can be deductible interest. 

In contrast, if you are taking a cash advance off your credit card to buy something, or going to a payday loan type place just to get some cash to go out for the evening – that is not deductible interest.

Wayne Kay  4:02  

And as we’ve learned before, it is a very bad thing. But yet people fall for it and seem to have to do it.

Derek Chase  4:10  

Yes, there’s choices every day. And just having more information about what happens with those choices, I think is powerful for people to understand – which is why I’m glad you’re doing these podcasts.

Wayne Kay  4:24  

So should we talk about how to avoid bad debt? What does that mean?

Derek Chase  4:29  

I think avoiding bad debt is just understanding that there’s different lenders out there and they’re not all created equal – in particular on the interest rates. My advice, if someone was going for a loan, would be to zero in and focus on that interest rate that you’re being charged and really consider whether that’s in a range that’s okay with you. Also ask yourself, can I deduct this interest or not? 

Another part to really shop for is whether there’s a large amount of fees for administration or some other sort of add on to the loan that you’re getting. And how do you avoid that? Well, I mean, I suppose if you’re sticking with mainstream lenders, you’re not going to get hit with that sort of penalty. But you know, just pay attention and shop around for better deals. Believe it or not, you can shop for different rates and terms, much like you’d shop for anything. 

Wayne Kay  5:32  

And I think that’s a really good point. I mean, the reason we’re doing this podcast is to educate and to teach people that maybe have never heard of an LI T – a Licensed Insolvency Trustee. They may not be up to date on how to go about shopping for loans, and what would be a too high of an interest rate. Because instead of looking at the interest rate, most of the times, they kind of just talk about the payment, not the rate.

Derek Chase  6:01  

For sure. And I think that another part of a bad debt is debt that takes too long to pay back. I can remember seeing a documentary on car loans that are getting stretched out well beyond seven years, or six, seven year car loan, and that’s just too long. Now, that car’s going to fall dramatically in value.

Wayne Kay  6:23  

Well, you’re not kidding. My son’s friend is a finance manager at a car dealership. He said the majority of the trucks he sells are in the $80,000 range. And eight year payments are pretty much what people are signing up for. And he said, people are fine with it for the first three or four years. But after that, they’re not fine with it, because you’re paying – you’ve just paid $100,000 and some for what is now worth 40 grand of a truck.

Derek Chase  6:50  

Yes, that’s hard to see at the time of the purchase. But when you think about it, it is a huge, huge payment still for a long time.

Wayne Kay  6:59  

Now, you mentioned 33% – that you’ve actually seen people come in. And obviously there’s financial troubles that are going on, and a lot of people get into this, and they don’t know where to turn. You see 33% – I mean, just to hear that is almost shocking to me, but I’m shocked with 20% through the credit cards. I think it is criminal – nevermind 33%. Are these rates not regulated somewhere?

Derek Chase  7:28  

Yes there are some, I think, typically provincial acts that are supposed to regulate interest rates. But I’m not entirely sure what’s going on with that. But it happens. And I think it always will. It’s just part of life. In order to avoid it – like I say, you need to be aware and find out what the interest rates are going to be. 

I also want to touch on another debt, Wayne, that I think is a bad debt. I think income tax debt is a bad debt. The reason I would put it in the bad debt category is just because the Canada Revenue Agency is very powerful in the way they collect. They can sometimes be unpredictable. 

I’ve talked to people who are diligently trying to pay down their income tax debt. And then all of a sudden, the representative on the CRA side of things changed. Then their deal wasn’t good enough, and then CRA can pull out their heavy hammer to start garnishing and draining bank accounts. So I would call income tax debt, bad debt as well.

Wayne Kay  8:35  

Yes, absolutely. What is that used – when you’ve made a bunch of money, typically as a solopreneur? Somebody who’s doing this on their own and they haven’t taken the taxes off that they need to and at the end of the year they owe whatever it is $5,10,15,000 in taxes, and they don’t have that money. That’s what we’re talking about.

Derek Chase  8:56  

Yes, often people who are self employed or aren’t having tax withheld at source. If you don’t file your taxes or pay your installments on time, the tax debt will will not only grow like you would imagine just slowly each year, but because of the penalties and interest that CRA can put on income tax debt. It takes off more like a jet fighter and the tax debt really starts to go high, really. So it’s not a not a good debt to have. But thankfully, we have solutions for that, as well as the other other types of debt.

Wayne Kay  9:33  

Well, let’s dive into what those solutions look like if you have too much bad debt. How do you go about conquering it?

Derek Chase  9:43  

Well, I think the first step is always just to get the facts down in front of you. Get the different types of debt down and what interest rate you’re paying. I would advise – if you’re going to pay it off on your own through your monthly budget – just pay down the highest interest rate one first. That makes the most sense to me.  

But if circumstances are such that there’s just too much of it coming at you from all different angles, then we get into the other options such as approaching your financial institution for some type of consolidation loan. And if you’re denied there, then there’s some very powerful tools that the federal government has allowed Canadians to use, the most popular one being a Consumer Proposal, where you can make an offer or a proposal to pay back a portion of that debt over time.

Wayne Kay  10:32  

So when we’re talking bad debt, typically, when you’re talking about Canadians, once again, we’re going to be talking about credit card debt. You said income tax debt is a bad one. Car loans, so they considered bad debt.

Derek Chase  10:46  

Well, that one could be good or bad, I suppose. If it’s a high interest rate car loan debt, that’s going to go on for eight years, I don’t think that’s a very good debt. And sometimes people get into that setting where they’re exchanging vehicles, and all of a sudden, they’ve got a relatively old vehicle with still six years to run on the loan. And, that’s another podcast that’s surrounding the creditors right to seize their vehicle. That type of law varies from province to province across Canada.

Wayne Kay  11:21  

So you’re saying what we do is we take a pen and paper and we figure out, okay, we owe this much money on credit cards, we owe this much money on a line of credit, we owe this much on whatever else. Figure it all out, figure out what their percentages are, and then aggressively go after and knock each one down at a time. Or do you? Can you go to the bank and say, Okay, I owe $10,000? And I’ve got a line of credit, or maybe you don’t even have a line of credit? Can you ask for a line of credit? Will they give you one?

Derek Chase  11:53  

You know, it’s definitely worth the ask. It’s the logical place to try. And I think the difficulty that people face is qualifying for that consolidation loan. Perhaps their credit rating just isn’t good enough for their bank, or perhaps their income level just doesn’t qualify, and the bank says no. And then what do you do? You have to search out your other options. And thankfully, there are other options that exist.

Wayne Kay  12:24  

I got to say that it annoys me a lot that the banks – It’s the credit cards that get racked up, and there’s not just one, but they’re offering all these credit cards that have these ridiculous rates. Then you get up, you’re in trouble, and then they won’t give you a normal something to bring down your interest rates.

Derek Chase  12:42  

Yes, it’s true. I mean, certainly the ease of getting credit is a huge part of why people find themselves with too much debt. When your credit limit is just raised automatically or out of the blue, and the debt keeps building. So there’s definitely that aspect to people having too much debt, that ease of credit.

Wayne Kay  13:07  

Okay, and what are some other tips – because oftentimes, you will kind of put on your counseling hat to help people through these situations. So that’s one of the tips, we’re going to do that. What’s the next thing you can do?

Derek Chase  13:19  

I think just reach out and get some information that’s specific to your circumstances. Most LIT’s across Canada will offer a free 30 minutes. So you know, why not take advantage of that? We talked to a fair amount of people who are somewhat shocked to learn that they can make a Consumer Proposal for income tax debts. They think that’s impossible, but in fact, it’s part of the law. 

In contrast, they couldn’t phone up income tax directly and say, hey, I’ll pay you 50%. That’s just not allowed. But if it happens through a Consumer Proposal, it’s allowable. So without that information, you’re in a totally different setting, and getting the facts down on paper, taking a hard look at your budget, trying to get that consolidation loan with your financial institution – these are all good things, but there’s still a Consumer Proposal. Or if you need another tool, there’s also a Bankruptcy filing that’s available federally – that can sometimes be the most logical thing to do.

Wayne Kay  14:27  

So you don’t have to struggle and try to pay this off. There is a way to really stop this, as you mentioned,

Derek Chase  14:35  

The best world is one where there’s no debt, but sometimes that’s not possible. And then if you get stuck in bad debt, and not good debt, sometimes that bad debt can create too much momentum to deal with and you have to look at other remedies. So it’s good news that other remedies are available.

Wayne Kay  14:55  

You can see how this happens. I mean, you deal with it every day but you can really see how you know, we’re going along, we’re living, we’re making all our payments, life is great. And then all of a sudden, you get something, you’re sick for a little bit of time, your income goes down, your debts go up – it grows a little bit. 

Or maybe all of a sudden, the company you’re working for restructures, you’re out of work and payments – the amount of money you have coming in, really drops substantially. And that’s a lot of stress. Because if everything stayed the same, you would have been perfectly fine and been able to pay off these debts. And I think people need to know – it happens. There’s so many reasons why bad debt can happen to people. 

Derek Chase  15:41  

I couldn’t agree more. There’s just a million different reasons that we see that can interrupt a person’s cash flow or create unmanageable debts. And, I can just think of the travel industry or the airlines that were full, full capacity, and then boom, here’s a pandemic for you. So there’s more reasons than we can list out that can cause financial difficulty.

Wayne Kay  16:07  

Yea. And if you see if you’re in one of those situations, and you’re listening here, you can reach out to Derek. And as he mentioned, the free consultation through a Licensed Insolvency Trustee could just give you a little bit of help with some options. It doesn’t mean that you’re going into Bankruptcy or anything like that. It just means that you’re getting a few different ideas.

Derek, is there anything else you want to touch on regarding our topic about debt, bad debt and making these payments?

Derek Chase  16:33  

I don’t think there’s anything to be afraid of with that. There’s good and valid reasons to get some lending assistance. It’s just you want to be well aware of your interest rate you’re paying and how long you’re going to pay it for and just be eyes wide open going into it.

Wayne Kay  16:48  

Terrific. Derek, thank you very much. I will have you back on the show. We always have great discussions. And once again, if you want to find out more information where you can go to the website, bankruptcytrusteebc.ca. 

And that’s it for today’s Debt Matters podcast. Make sure you subscribe wherever you get your favorite podcast from. And of course, for more information, you can always check out debtmatters.ca I’m Wayne, thanks very much for listening.