How to approach your debt during COVID-19

COVID-19 has hit many people hard. The economic impacts of physical distancing are being felt by more and more of us as the pandemic drags on. Aside from making sure our day-to-day bills get paid, many are wondering how they’ll be able to service their debts as the weeks continue. 

Whether you’ve lost your job or are still working, here are some tips on how to approach your debt in a pandemic-induced recession.

Plan instead of panic

The first thing you need to do when it comes to handling debt during a crisis? Take a step back and take a deep breath.

Scott Terrio, an insolvency trustee at Hoyes Michalos & Associates, says that people often panic when financial uncertainty arises, which can cause them to make bad decisions. But you don’t want to be making the wrong moves that could cost you down the road.

“There are a lot of rules that people might not know about, and it can be hard to undo them,” says Terrio. For example, socking cash away in a registered retirement savings plan when you know you might need to file for insolvency is a big no-no, since there’s a clawback provision in insolvency law that allows creditors to seize your last 12 months’ worth of RRSP contributions in certain cases.

Most people won’t understand the financial implications of this pandemic until months from now. That’s why it’s crucial to come up with a plan to manage your debts by speaking with a professional who can advise you on the best way forward.

“It's very natural to not face up to stuff, especially financial problems, because it's embarrassing,” he says. “But you need to make sure you've got a sensible plan in place, instead of just coasting along.” 

Separate credit from assets

During a financial crisis such as this one, Terrio recommends that your daily banking account not be with a financial institution that you have credit products with. This is because the bank can enact what’s known as the “right of offset” — where they can take any money you have to offset an overdue payment. Ensuring your creditors don’t have access to your assets means they can’t automatically take any funds you had earmarked for essentials, such as food and housing. 

Other things you can do include getting in touch with creditors to see if they will lower your interest rates. Most major banks are offering lower credit card rates for consumers affected by the new coronavirus, as well as payment deferrals.

If you’re having trouble making rent or mortgage payments, speak to your landlord or mortgage holder about deferring payments in the short term. You can also call your auto insurance provider to see about having your premiums reduced temporarily. 

Pay what you can

Terrio highlights the fact that courts are currently closed and banks are redeploying staff from collections to other areas as a means of giving people peace of mind they don’t need to act right away. 

“Everybody's creditor-proof right now so to speak,” he says. But just because you can’t make a full payment, doesn’t mean you shouldn’t make one at all. Terrio advises people to continue to use any income they have to pay for what they need to, and not worry too much about any short-term hit their credit score might take.

“Maybe you have to skip a month or two's worth of minimum payments on your credit cards because that's thousands of dollars,” he says. “Or maybe you pay every second month or something just in the interim.”

Terrio says he’s spoken with many people who think deferral means forgiveness, but that’s misguided. “You're never going to see debt forgiveness from a bank, period.”

Build some savings

If you’re lucky enough to be in a position where you still have your regular income, you might find there is a surplus in your monthly budget now that you aren’t commuting to work, paying for childcare, or buying that morning latte on the way to the office. If so, you can use this windfall to pay off any debts you currently have, then start building an emergency fund. 

Paying off your debts can free up some wiggle room in your monthly budget moving forward, in case you happen to be in a less financially stable position a few weeks or months from now. And building an emergency fund will help you through financial instability as well. Your emergency funds should represent approximately three months’ worth of your fixed expenses.

Terrio says this can be as simple as having your employer update your payroll information to make an automatic deposit into a designated savings account, or a tax-free savings account. 

“Now you've got a cushion that you never had before,” he says. “That way it's like having tax taken off at source. All of a sudden you've got two or three thousand dollars in an account. And it doesn't take long.”

Leave your investments alone

While a cash shortage can leave you looking to liquify your assets, many financial pros advise against this tactic, especially when speaking with younger investors. Terrio notes that not only is there 30% tax when withdrawing from a registered plan, there’s also the fact that this money is counted as income and could bump you up into a higher tax bracket when you file your income tax return next year.  

“You don't want to come out of this with a tax problem on top of everything else. If you can not cash out a registered savings plan, you're probably going to save yourself a massive hit down the road.”