Debt: What It Is and How to Handle It
A debt is money owed by one person or entity to another.
You get into debt by borrowing money with the agreement that you will pay it back, often by a certain date.
Usually, debt also incurs interest, a percentage of the amount borrowed. Interest is paid to the lender, and it can make your total debt more expensive than the amount you borrowed.
Interest charges are an incentive to pay off your debt as quickly as possible.
Debt isn't always a bad thing
Ideally, you don’t want to have to deal with debt.
That said, a debt-free life isn’t a reality for most people. Life is expensive, and some purchases exceed the cash we have in savings. In order to pay for them, we need to borrow money.
Most Canadians have some sort of debt during their lives: student loans, maybe credit card debt, or even a mortgage.
While it’s a good idea to avoid too much debt, debt can sometimes be a tool to help you achieve your long-term financial goals.
Good debt
Good debt is any debt that will add value or increase your net worth. For example, student loans and mortgages are considered to be good debt. Your student loan can help you qualify for a job and, ideally, earn a higher income throughout your career. And generally speaking, the value of the home you’ll buy with a mortgage will increase over time.
Bad debt
Bad debt is money borrowed for things that will depreciate in value over time. For example, credit card debt and car loans are sometimes considered to be bad debts. These types of loans often have higher interest rates. For example, the majority of credit cards charge 19.99% interest.
Keep in mind that the terms good and bad debt are relative and subjective.
Depending on your circumstances and cash flow, debt that might initially be considered good or bad could get reclassified. A car loan for a luxury vehicle with high payments you can’t really afford would be bad debt, but a loan that helps you buy a used car so you can commute to a higher paying job might qualify as good debt.
How long does debt last?
Debt persists until it is paid off, or until the borrower declares bankruptcy.
Different types of debt have their own payoff timelines, often called terms or amortization schedules. A mortgage may have a 25 years term, a personal loan may have a five year term, and a credit card is intended to be paid off every month.
To avoid serious financial consequences, debt must be repaid according to the terms and timeline you agreed on when you borrowed the money.
If you cannot pay off your debt, you will likely be approached by a debt collector, who has a certain amount of time to take legal action against you in order to recover the money owed. In Canada, each province has its own statute of limitations, which range from 2-6 years.
This is a worst-case scenario and, ideally, you should pay your debt as soon as possible, working directly with your creditors, so you don’t have to deal with debt collectors.
Can I inherit someone else's debt?
If you have ever wondered what happens to your debt when you die, know that it does not disappear.
Secured debts, like mortgages and car loans, stay attached to your home or car. Your estate will need to pay them off, or your heirs will need to pick up the tab — or even sell the items to pay off the loans.
Debts owed to the government, like taxes, also need to be paid out of your estate.
Your credit card debt will also come out of your estate, but the issuer might simply write it off if there isn’t any money left. However, if you held a joint account with your spouse or partner, they will inherit that debt.
Understanding the severity of your debt
Debt-to-income ratio is a common formula used to figure out how much debt your household carries in relation to your net income.
This statistic is used on a national level to determine Canada’s financial health. It is also required on a personal level when you apply for a mortgage since the lender wants to ensure that you’ll be able to make your payments.
To figure out your debt-to-income ratio, divide the sum of your monthly debt payments by your monthly income. Then multiply the result by 100% to turn that number into a percentage.
For example, say you make $5,000 per month. You also have a $1,200 monthly mortgage payment and a $500 monthly car payment. This means you pay $1,700 toward debt each month.
$1,700 ÷ 5,000 = 0.34
0.34 x 100% = 34%
Since this is below 36%, it’s considered a good debt-to-income ratio, as it’s assumed your monthly income can cover your debts with something left over.
However, a debt-to-income ratio of 43–49% is concerning, and a ratio of 50% or higher is likely to be problematic.
Once I'm in debt, how do I pay it off?
The best way to pay off debt depends on the type and amount.
Fixed payment loans typically have set monthly payments. If you make each payment on time and in full, you'll pay off the loan completely in the timeframe stated in your loan agreement — such as 36 months or 25 years.
Revolving debt, such as credit cards or lines of credit, work a bit differently. With these debts, it can be easier to borrow more than you can pay off in a month, and interest rates keep your balance climbing higher each time it rolls over to a new month.
Two common strategies to pay off larger amounts of high-interest debt are the snowball method and the avalanche method.
Snowball method
Make a list of all your debts in order of the size of the balance.
Pay the minimum payment on all of them, except for the smallest debt.
Pay as much money as you can afford toward that smallest balance until you’ve paid it off.
Then move on to the next-smallest balance.
Repeat this process until all debts are paid.
Avalanche method
Make a list of your debts in order of the interest rates.
Pay the minimum payment on all your debts, except for the one with the highest interest rate.
Pay as much money as possible toward your highest interest debt each month, so that it's paid off as rapidly as possible.
Once your highest interest debt is eliminated, use the amount you were paying toward it to start tackling the next debt on your list.
Both of these strategies can be successful, as long as you stick to them. The avalanche method will save you the most money over time since it minimizes the amount of interest you pay. But the snowball method offers quicker “wins,” which could help keep you motivated to pay off your debt.
If your debt becomes overwhelming, ask for help
Dealing with debt can be stressful. Don't be afraid to ask for help from a professional debt counsellor. They may be able to assist you with other options, like debt consolidation.
If you have several debts and are having a hard time keeping track of them, you can consolidate them by taking out a loan and using it to pay off all the other debts.
While you’ll owe a large total balance on this loan, knowing that you only have to make a single payment every month can help relieve some of the stress and anxiety caused by debt.
Not all debt relief and credit counselling agencies are legitimate; some can be predatory. Be careful when signing up for any debt management plans. This resource from the Government of Canada can help you find a reliable and credible credit counsellor near you.
What happens I don't repay my debt?
Missing debt payments is going to earn you some immediate attention from your lender.
First, they may slap you with a late fee or some other sort of penalty.
Then, they may reach out to you in writing, warning you about more penalties and potential legal action.
If the debt remains unpaid, and you can't work out a repayment plan with the lender, your account will most likely be turned over to a debt collector.
Dealing with debt collectors
Debt collectors work for collection agencies. These agencies are hired by creditors to help collect outstanding debt owed to them.
Since this is their full-time job, collection agents may be even more aggressive than your original creditor. They may call you constantly. They may even contact your employer, friends or family.
Dealing with debt collectors is generally an unpleasant experience, and can damage your credit score, which is why it's best to try to resolve things with your original creditor whenever possible.
If you're contacted by a debt collector, stay calm and take the following steps. And make sure you write everything down.
Ask for the agents name and the company they work for.
Ask who or what they're collecting money for.
Ask for their phone number.
Ask for specific details about the debt: amount owed, the name of the creditor, the date the debt was incurred.
Once you have that information, tell the debt collector that you're going to verify their information and will call them back.
Take a look at your bills and bank statements to make sure the debt collector's information is correct. It's not uncommon for debt collectors to get the wrong person or the wrong amount of debt.
» The Financial Consumer Agency has helpful tips about what to do next — whether it's repayment or correcting an error.
Know your rights if a debt collector contacts you
Collection agencies must adhere to the laws and codes of conduct set by the provinces and territories in which they operate. While standards may vary from province to province, there are some common rules about how debt collectors must conduct themselves.
✅ In Ontario and B.C., debt collectors must send a written request to collect your debt — including the amount you owe, the creditor, the name of the collection agency tasked with collecting the debt and a way to contact them. Then, they must wait six days before they can start calling you.
✅ You can tell a collection agency to communicate with you only in writing. A lawyer should send this request to your creditor by registered mail. The letter should include your current address and phone number.
✅ Debt collectors can take legal action against you by trying to garnish your wages, but they only have two years to pursue legal action, and any debt in collections is purged from your credit report after six years of inactivity.
❌ Debt collectors cannot call you whenever they want. Debt collection calls can legally occur from 7 a.m. to 9 p.m. Monday to Saturday, and 1 p.m. to 5 p.m. on Sunday, and never on holidays.
A collection agency can call your work, your friends and your family, but there are limits to what those calls can entail.
They can only call your workplace to verify your employment and once they do, they can’t call there again.
They cannot tell your employer or your co-workers about your debt.
They can call your friends and family, but only to verify your address and phone number. They can’t harass your family and can’t tell them to pay your debt unless a family member is a co-signer on the loan or line of credit.
❌ A collection agency cannot charge a higher interest rate than the original lender.
What to do if a debt collector isn't following the rules
If a debt collector is in violation of federal or provincial rules, you can file a complaint. If the debt collector works for a bank or other federally-regulated institution, make your complaint with the bank directly.
If the debt collector works for a third-party agency, you'll need to contact your local consumer affairs office.
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