How to break the cycle of debt

Between inflation, housing costs and interest rates, debt is ballooning for many younger Canadians.

Scott Terrio sees it all the time. The manager of consumer insolvencysays the average credit card balance in Canada is less than $4,500, but the cases he saw last year averaged more than $12,000 for this young group.

Terrio helps clients cut deals with creditors and avoid bankruptcies, if possible, at Hoyes, Michalos Licensed Insolvency Trustees. Looking at his 2023 filings for clients aged 18 to 29 across Ontario, he said average credit card debt was up 34.5 per cent from 2022.

Jeffrey Schwartz, executive director of Consolidated Credit Counseling Services of Canada Inc., notices the same trend. The national non-profit organization usually works with Canadians on education and debt restructuring but also sometimes refers clients to insolvency firms if their situation is dire.

“We looked at Q1 for 2023 versus Q1 for 2024,” Schwartz said of the firm’s clientele. “And specifically for those people that were under 40, in our client base, we’re seeing that the debt loads for those people has increased about 27 per cent. Like all of a sudden, when people aren’t making that much more, if anything more at all…not to mention the interest rates that have gone up over the last little while, then it becomes more and more of a challenge.”

This represents a large demographic for Consolidated Credit, he added. Over half of its clients are under the age of 40.

Terrio said his clients show up with the “typical Canadian financial life” — starting with a credit card at 18 and a student loan, then card companies keep increasing the limit and consumers run up their debt. Seeing the interest load, these people then get a line of credit with lower interest rates and transfer the balance there.

Now, Terrio said, they feel relieved — and they keep spending.

Once they flip their debt to a line of credit, he said consumers should cut up their credit card and live on cash flow as much as possible. But their debit card sits unused, while they keep tapping credit everywhere instead.

“They run their Visa back up because they didn’t cut up their card,” Terrio said. “So now the banks got you three times, and they got you for life.”

Terrio said it’s the same story over and over again, and is critical of ever-increasing limits offered to young people when financial literacy is typically at its lowest.

“I’m always the first person these people have spoken to who’s helped them in their financial adult life,” he said.

It’s impossible to ignore current market conditions, however.

As Schwartz pointed out, Canadians are feeling the squeeze between incomes that haven’t kept up with the cost of living, housing crises in markets across the country, and rising interest rates brought in to control inflation.

Managing spending and debt becomes a tightrope act, especially for younger people, Schwartz said.

“So with the advent of social media, and the ease with which someone can buy something online, we’re finding that consumers have adopted these behaviours whereby they’re trying to keep up with their friends and family,” he said.

He also warned against so-called lifestyle creep, when people start making a bit more money, and just start spending more.

“They may see a slight increase in their income, and they think, ‘Oh, I just kind of hit the lottery, and now I’m going to spend like crazy,”‘ Schwartz said. “And it’s tough to change those behaviours after it’s been ingrained for a long period of time.”

To prevent this from happening, track spending diligently — you can download apps for this purpose — and delay milestones such as moving out or getting a car if you can, Schwartz said. Build up an emergency fund in case you lose your income or suffer a financial setback, to avoid falling into serious debt.

“If you have the opportunity when you’re young, when you’re not spending as much on rent, you’re not spending as much on food, if you can cut back on how much you’re socializing — that’s a great place to start to build up that reserve fund,” Schwartz said.

Live within your monthly cash flow — using your debit card or cash — and develop a short-term austerity plan to make big strides on debt repayment, Terrio said.

Summer months are tough for austerity because you want to socialize, he pointed out, but January through March are a good time to adhere to a severe budget. Up to 40 per cent of your non-rent income should go to debt, Terrio said, noting short-term austerity is tolerable because it’s over quickly.

Ultimately, the aim is to reach the tipping point when at least half of your debt payment is going to the principal — and the portion going to interest starts to slide. Never use an instalment loan, he added.

“All these 36 to 48 per cent interest loans that are $10,000 — if you get one of those, you’re done,” Terrio said. “You’re never, ever getting out.”

Once you’re free of debt, stay that way. Keep your credit limit low and turn down offers to increase it, Terrio said. If you move debt to a line of credit, stop using your credit card.

“You decide how much debt you’re going to have, not the bank, right?” Terrio said.

“I know it’s tempting. If they give you a credit card for $20,000, don’t take it, just take $5,000. Because if you get into $5,000 debt, we can fix that. You can fix it. If you get into $20,000, I have to fix it, right? You’re in my office.”