The biggest mistake in trying to control and pay off debt is not to get rid of high-yield debt first. You have to prioritize two factors: the interest rate to be paid and whether it is tax deductible or not. Credit card debt for consumer use is the most damaging because a) interest rates are burdensome nearly 20% per year; and b) there is no way to deduct the cost of this interest from your taxes.
With that in mind, the obvious conclusion is to pay off high-interest, non-deductible credit card debt before any other debt – student loan and mortgage debt, which are usually associated with much lower interest rates.
The second biggest mistake is the repayment of non-tax deductible debt before valid tax deductible debt. You may be wondering which debts are tax deductible? Well, if you are a business owner, you may have a company credit card that you use only for valid business expenses, which should therefore be deductible from business income: valid car costs, office supplies and equipment, various professional services, and the like.
It is better not to make credit card debt at all, but if other things are the same, you should prioritize repayment of your personal non-deductible credit card spending over corporate deductible expenses. Even if you’re an employee, you can also be an investor who believes in leverage: you borrow money to top up your equity portfolio in taxable accounts. These debts are usually tax deductible.
It is important to know the difference between debt with tax relief and debt without tax. Consider homeowners taking out a first mortgage to buy a rental property as an investment. The rental property often has less debt than the main residence. The winners are the bank that lent you the money and the income taxpayers. The interest expense on debt secured by your primary residence is not tax depreciation, but when you hedge the loan with a rental or investment property.
Unlike the US, Canadian mortgage debt for your primary residence in Canada is unfortunately not tax deductible unless you are in one of these complicated systems like the Smith Maneuver. Sandy Aitken from M-link Mortgage Corp. wrote an entire book (Mortgage Free) that describes how you can restructure your affairs to do so.
“Simply put, if you’re in the highest tax bracket and your loan interest payments are tax-deductible, you’ll get more than half of your money back,” Aitken says. “When you borrow money to invest in the market or in a company or in a company.” Real estate that generates income, then loan interest payments are likely to be tax deductible. “
With that in mind, Aitken says the biggest mistake Canadians make is that they tend to save and invest their own money while borrowing to spend on credit cards. “Never borrow to spend money! Borrow money to invest – and use your own money to spend! “
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