How to Get Out and Stay Out of Debt
Part 6–So the Bank Said “No Way, José,” Huh?

Oh Dear...So you asked your bank for a line of credit (LoC) but they looked at you and laughed, huh? Gosh, I’m sorry to hear that! It would have been helpful but either the bank rep you spoke to is an asshole or your credit is so bad that it was high time that you started doing something about it.

Well okay… *SIGH* No point crying over spilled milk. At least if you’re still reading through this series, it means you’ve done your homework and you know that there’s more money coming in than there needs to go out, so you’re not a candidate for bankruptcy …at least not yet. That’s if you told me everything, right? For if indeed your needs including minimum payments on your credit cards have you right up against the wall with no room to move, then yeah, maybe you came too late to the realization that you’re in deep financial trouble.

Maybe that’s why the bank laughed at you.

Oops! Sorry… Oh cheer up! Perhaps my method can be applied in the framework of a consumer proposal plan or, if it’s really bad, outright bankruptcy. If you’re well behaved, you’re likely to be given very limited credit in a year or two to prove you can be responsible with credit and at the same time start rebuilding your credit history while you’re still under bankruptcy (NOT under a consumer proposal, though), which typically last 7 years. And you’ll definitely be able to use my method to do that and stay out of debt afterwards.

Wait! What’s that? You’re not up against the wall? My method showed you that you DO have some manoeuvring room but it’s just that the bank didn’t buy into your idea for a LoC?

Well then, in that case, there’s a well-known tried-and-true alternative for you. I don’t like it as much as the LoC method because you’ll end up having paid a lot more interest by the time you finish getting out of debt, not to mention that you’ll have to keep your eyes on several balls at once. However, if those are the cards you’re being dealt, you’ll just have to grin a bear it.

The Debt-Stacking Method
Here I’m just going to point you to Wikipedia.

The debt-snowball method is a debt reduction strategy, whereby one who owes on more than one account pays off the accounts starting with the smallest balances first, while paying the minimum payment on larger debts. Once the smallest debt is paid off, one proceeds to the next slightly larger small debt above that, so on and so forth, gradually proceeding to the larger ones later. This method is sometimes contrasted with the debt stacking method, also called the “debt avalanche method,” where one pays off accounts on the highest interest rate first. (emphasis mine)

As you have guessed from what I’ve written previously, I prefer getting rid of the debt with the highest interest rate first, regardless of whether it’s the smallest or the largest. I understand that it might not reduce your number of debts quite as fast, but the interest rates are the real killer.

Before you even start, you should also see if you can transfer the balance from your high-interest cards to the lowest-interest card you have, effectively still attempting a kind of consolidation. In fact, while the bank may not have wanted to give you a LoC to consolidate your debt, it might accept to replace your current card with one with a low-interest option and transfer the balance onto it. Since this card will become your LoC substitute, you can only add extreme “contingency” spending on it, like a flat tire or something you couldn’t reasonably see coming because, from now on, that’s the only way you’ll ever be using credit.

The bank will probably try to talk you out of their low-interest option card if you’re the one who brings it up, though. They’ll say stuff like, “Oh, but there’s an annual fee of $20 on that one and yours has no annual fee, plus it doesn’t give you any air miles/cash back,” but just give them your best “Are You Seriously Kidding Me” look because $20 is a drop in the bucket compared to how much you owe and how much interest you’ll have to pay on your lousy current card. They’re making more money on your back in the pickle you’re in now, thus why they’ll resist the idea of the low-interest option card.

So here’s a simple illustration. Let’s say that you have 5 accounts to which you owe and $225 per paycheque to distribute. Instead of doing one payment per month, you’re going to use my reserve method which is every 2 weeks (assuming you get paid as I do). The most “expensive” debt (highest interest rate) is in the first column, the second-most “expensive” next, and so on. If two are as “expensive,” then put the smallest amount owed first so that you can get the kick of seeing that one fall off sooner.

Description Debt 1 Debt 2 Debt 3 Debt 4 Debt 5
Minimum Monthly Payment 45.00 27.00 160.00 9.00 31.00
Week 1 Minimium Payment 22.50 13.50 80.00 4.50 15.50
Week 1 Top Up 89.00 0.00 0.00 0.00 0.00
Week 2 Minimium Payment 22.50 13.50 80.00 4.50 15.50
Week 2 Top Up 89.00 0.00 0.00 0.00 0.00
Paid Over Two Periods 223.00 27.00 160.00 9.00 31.00

Assuming you’re not adding any more to these debts (ahum!), the next series of minimum payments should be lower, although the difference should be most noticeable for Debt 1. Repeat half the minimum payment per period on all cards and the remainder of what’s left to distribute on Debt 1.

Eventually the balance owed on Debt 1 might be the minimum payment plus a portion of the available “top up” amount, so in that case you’ll be in a transitional period when you’ll be able to put some extra on two debts. (The minimum payments below are for illustrative purposes only and could be higher or lower depending on balance owed, interest rate, time, and so on.)

Description Debt 1 Debt 2 Debt 3 Debt 4 Debt 5
Minimum Monthly Payment 5.00 24.00 145.00 5.00 28.00
Week 1 Minimium Payment 2.50 12.00 72.50 2.50 14.00
Week 1 Top Up 98.78 22.72 0.00 0.00 0.00
Week 2 Minimium Payment 0.00 12.00 72.50 2.50 14.00
Week 2 Top Up 0.00 124.00 0.00 0.00 0.00
Paid Over Two Periods 101.28 170.72 145.00 5.00 28.00

Be careful, however, with Debt 1! There might be residual interest to pay from the last month during which you had a balance owing, so you’ll have to throw a few final dollars on it before you can finally consider it really done.

It’s also possible that a debt like Debt 4 in the illustration above might be ripe to be wiped off by topping it up now rather than waiting for its time mathematically. I know that it would make me feel good to knock it off if part or the entirety of the Week 2 top up would be enough to do so even though that debt is not as expensive as Debts 2 and 3. So I leave that up to you!

There’s another thing you need to consider. Maybe the amount you can put toward your debt is so low that, although you can implement this debt-stacking scheme, it will take you more than 3 years to find yourself debt-free. If so, you’re risking debt repayment fatigue.

In that case, if I were you, I would use this scheme for one year and then go back to the bank and try again for a LoC so that you can benefit of the much lower interest rate it imposes. Always paying all your minimum payments for a year — and possibly having paid off a debt or two — will have done a remakable amount of good to your credit rating. And maybe — maybe! — the bank will see that you’re serious about restoring your financial health, so this time they might not laugh you out of the bank when you ask for a LoC.

If they do, change bank.

Your Credit Score = Your Profitability, Not Your Financial Health
Unlike what you might think, your credit score is not about your financial health. In other words, it’s not as much about your trustworthiness with credit as it is about your profitability to lenders. They WANT you to carry a balance. They WANT you to pay only the minimum balance. That’s how they make money on you.

Ironically, while you’ll be following this scheme for a while and pay all your minimum payments and then some in a few cases, your credit score might eventually become better than mine! That’s because lenders don’t like someone like me (and what you’ll eventually become) — someone who pays off his cards in full every month. I’m not profitable in the eyes of lenders. In fact I’m their worst nightmare because I make money off my main credit card!

Your credit score might even take a hit for a few months after you close an account you’ve paid off, so instead you might consider keeping those cards but sticking them under the fridge. However, when you get to be my age and reach not only debt-free status but also have real savings socked away, you won’t really care about your credit score because you won’t need credit that much anymore. Yet if you do need to get a big loan, you’ll be able to point to your assets instead of relying on that score which, quite frankly, is biased since it doesn’t represent what you perhaps always thought it represents…

< Previous     Next >