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Could you survive a 10% reduction in your income?

Would your financial well-being be noticeably affected if your paycheque dropped by 10%? For most of us, the answer is “yes”. We tend to live paycheque to paycheque, so any drop in income can lead us down a slippery slope that often ends with a person filing bankruptcy in Canada.

CPA Canada did a study titled: Where is the Money Now: The State of Canadian Household Debt as Conditions for Economic Recovery Emerge. They surveyed Canadians and discovered that 50% of Canadians believe that their financial well being would be noticeably affected by a 10% salary decrease.

Think about it: if you get a paycheque of $500 per week, what would happen if your paycheque was cut to $450 per week? Would you still be able to pay your living expenses, and service your debts? Obviously for many Canadians a 10% cut in pay would severely impact on their ability to pay their bills every month.

As a bankruptcy trustee in Ontario, I meet with many people each week who have experienced a reduction in their income since the recession started two years ago. For some, the income reduction is relatively minor. They went from averaging two or three hours of overtime a week, to no overtime. It hurts, but they still have a full 40 hour paycheque. For others, a long term or permanent layoff drastically reduces their income.

In a perfect world, we would all have no debts, and lots of money saved in our RRSPs and bank accounts. If we did, a job loss would be a minor inconvenience. With no debt to service and with cash in the bank, we could take our time looking for a new job. We might even take a vacation before we start our job search.

Unfortunately very few of us live in a “perfect world” of no debt, and lots of cash in the bank. As I reported two months ago in my article on Personal Debt in Canada: The Ticking Time Bomb:

Despite the recession, or perhaps because of it, Canadians continue to borrow at record levels. By the end of the third quarter of 2009 the average Canadian adult had over $40,000 in household credit, a record level. Household credit includes credit cards, bank loans, and mortgages, so $40,000 may not appear to be a large number. After all, many people have mortgages of greater than $40,000. That’s true, but many other Canadians don’t have any mortgages or debt, so to average $40,000 over all adult Canadians, many of us are obviously carrying a significant amount of debt. As the chart shows, back in the year 2000 we each had approximately $20,000 in debt, so in less than a decade the debt we are carrying has doubled.

That’s a staggering statistic. If you are the average Canadian, your debt has doubled. Has your income doubled? Are you making twice as much today as you were earning in the year 2000? Probably not. If you still have a job you may have received “cost of living” increases of 2% per year for the last decade, but that obviously does not add up to a doubling of your income.

And that’s the problem: In Canada our personal debt continues to increase, but our incomes are not increasing nearly as fast, so we are spending an ever increasing amount of each paycheque servicing our debts.

It is very common for me to meet with people who are spending a third, or even a half, of their total income just making payments on their debts! One hundred years ago there was virtually no debt. Fifty years ago the only common type of debt was a mortgage on a house, or perhaps a small amount of credit at the local department store. Today, most of us have a mortgage, car loan, line of credit, student loan, and one or more credit cards where we carry balances.

That’s a lot of debt, and it makes us very vulnerable to any shock to our income. Missing a day of work can literally, for many Canadians, put them over the edge and make them unable to pay their bills.

What’s the solution?

Obviously we must all start taking responsibility for ourselves. There are those that will argue that our high debt levels are the fault of the banks and finance companies that lent more money than we could ever hope to repay, all so they could earn huge profits. Others will argue that it’s the government’s fault: they should pass rules to protect us. Those are valid arguments, but I choose another explanation: I choose to believe that I am responsible for myself, and my family.

I believe we should all stop worrying about the banks and the government, and look out for Number One. Ourselves. We should each decide what we need to borrow, and we should not respond to high pressure sales tactics from banks, car dealers, real estate agents, or anyone else who is trying to get us to borrow to buy something we can’t afford.

I remember meeting a man about six months ago who was in way over his head in debt. He had a very nice house, two leased cars, and a very comfortable lifestyle. About a year ago he lost his job due to the recession. While he was working he could afford to pay the mortgage, car loans, and all of his living expenses, and he borrowed to take vacations and buy various luxury items. But when he lost his job, with no savings, he immediately started using credit to survive. By the time I met him he was deeply in debt.

After much soul-searching, he made two very difficult decisions: He sold his house and moved into a smaller rental unit, and he returned his two leased cars, and replaced them with a much less expensive used car. He cut back on eating out and other expenses he couldn’t afford.

He found a new job, that paid well, but not nearly as well as his old job. To deal with his debts he filed a consumer proposal, and expects to have it paid in full in under two years.

He told me that even though he no longer lives in a huge house, and no longer drives a new car, he is actually much happier. He knows that even if he was to lose his job, he could survive while be found another job, because his expenses are now much lower.

And that’s the key to dealing with debt and surviving during these difficult times: Reduce your living expenses so that they are as low as possible, so that if you suffer a 10% reduction in income, you are still earning enough to pay your bills. It’s not easy, and you won’t be “keeping up with the Joneses”, but you will have cash in your pocket at the end of the month, and that’s a great feeling. If you have more debt than you can handle, consider your options, and begin the process towards a debt free life.