Non-deductible interest on household debt is the second largest expense for many folks over their life times. First of all people need to let go of the thought that all debt is bad. That is not the case; most people today wouldn't be able to afford a home or car if we weren't able to borrow money. It's when the ability to borrow is abused that we run in to trouble

"Ugly" debt
Credit cards, lines of credit and consolidation loans.

The reason for referring to this type of debt as ugly is because it is the easiest debt to abuse, lots of people use them as if they were cash, the interest rates are often expensive and if you don't' change your current habits they are always hanging around racking up interest.

When I look at a credit card statement most people can't tell me what the balance came from changes are they are still paying for dinner from 6 months ago if they are not paying the full balance down every month. Credit cards and lines of credit are great tools but they are very dangerous if you don't use them properly. Consolidation loans can be particularly problematic for some folks they often have mid-high interest rates they usually have sizable monthly payments to shorten the amortization and very little flexibility. The worst part is if you've gotten a consolidation loan and changed none of your money behavior you'll just be ready for a new one when this one is paid off.

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"Neutral" debt

Your mortgage, at least you've borrowed to purchase an asset that should appreciate over time and if you sell that asset as long as it is your primary residence at the time you'll not pay tax on the gains. However with many companies offering longer amortizations and homeowners constantly refinancing once again this can become an endless cycle of borrowing every time your home appreciates in value. However certain mortgage products can be used to maximize the effect of your cash flow to save interest and pay your debt down faster while allowing you to afford to invest as well.

So what's good debt and can any debt really be good??

"Well yes there is such a thing as good debt."

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"Good" debt

The interest on your borrowings is tax deductible usually that means the borrowings are working for you to increase you net worth. For example, if I had a client that had to choose between retirement debt free but in order to pay off the debts would have little or no assets or a client is still in debt but has accrued some tax efficient investments. I'd recommend the client concentrate of the assets and while still paying down the debt do not do so at the expense of their investments. This is because a client who retires with no assets and no debt will soon have no options if they need more than their pension plans can provide (a very common problem). That client if they had paid off their home would be looking at refinancing or borrowing of some manner to come up with excess funds. However the client who retires with some debt but also has tax efficient assets will have many more options which so incredibility important now that we are seeing lots of people live 25 years plus in to retirement.

So what kind of debts is the interest tax deductible on?

When you borrow to invest you can deduct the interest costs from you taxes as long as the investment qualifies under current CRA rules* There are two benefits to this one you get to write off the interest expense from an investment loan and two the proceeds of these types of loans can be invested in non registered funds which unlike RRSP's are not 100% taxable upon withdrawal. In fact only gain is taxable and, many non-registered investments will qualify for preferable tax treatment.

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Debt Diversification

Diversification is good right? Is that what we are always hearing these days? Diversification of debt means several different methods of borrowing with in one household. Well diversification is good for investments when trying to minimize risk while growing your money. So why would we use a concept that grows investments on debt? Wouldn't that cause the same thing GROWTH, isn't that the opposite of what we want to happen with our debt. While some diversification might be necessary, depending on an individual situation, minimizing your different loans and financing (excluding those that are tax deductible) can usually save time and money especially on interest.

Each individual financial situation is very different make sure you seek professional advise specific to your financial situation.

There are many tools to help make debt management a cost efficient and tax efficient experience.
Are you employing these tools?

Do you want to find out more about how you can improve your
debt management and save interest dollars?

*Tax rules can change at any time before borrowing to invest be sure you are dealing with a professional who is used to working with such tax efficient strategies and consult an accounting professional. Leveraging magnifies the performance of an investment both positive and negative which may increase your risk, leveraging should only be used as part of a comprehensive long term financial plan.

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