DEBT
Control The Money You Borrow
What is debt ?
Debt is money borrowed by one party from another. Debt is used by many companies, organisations, institutions and individuals as a way of making large purchases that they cannot afford under normal circumstances. A debt arrangement gives the borrowing party permission to borrow money from another person or institution , with the intention of paying back the money at a later date, usually in instalments and with interest.
Understanding debt
Types of debt:
Secured debt: This is a loan that is granted against an asset, usually a house or vehicle, which is used as collateral against the loan. Simply put, if the borrower does not honour his/her payments over time, the lender can take ownership of the asset and sell it to recover their money. The interest rate on this type of debt depends largely on the credit rating of an individual.
Unsecured debt: This includes credit cards and personal loans, against which there are no assets to act as collateral. If the borrower defaults, the credit providers may take legal action to recover their money. This type of debt usually comes with a higher interest rate due to the risk of the loan.
Causes of being over indebted
Let’s first learn what it means to be over indebted.
This is when you cannot make your repayments on time, and still afford your living expenses. This can also happen if people incorrectly calculate their debt repayments.
Causes for being over indebted:
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A lack of financial understanding
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Easy access to credit
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Signing surety for someone else’s loan
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Lack of financial management
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No distinction between wants and needs
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Worrying about your social status
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Suspicious investments
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Lending money to friends or family
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Medical expenses
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Family events
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Sudden job loss
Know the difference between good debt and bad debt
Good debt
Good debt is money that you borrow in order to make more money and buy things that grow in value or bring a profit in future. The purpose of good debt is to enhance your financial wellbeing in the long run, not immediately. Education is an example of what good debt should be used for because the more educated a person is, the better their career prospects are. Starting your own business is another good example because having your own business can be very rewarding, financially and for your own self-worth, even though there are always risks. Investing in your house is also considered good debt because upon reselling your home you should make a profit.
Bad debt
Bad debt occurs when money is borrowed to buy things that will decrease in value in the future. A good example of this is buying a car which loses its value from the moment you drive it off the showroom floor. Borrowing money for clothes, furniture and even food are other examples of bad debt because, while we need these things, they will bring no profit after their purchase.
Debt to income ratio
Comparing how much you owe each month to how much you earn, indicates your debt-income ratio. Specifically, it is the percentage of your gross monthly income (before taxes) that goes towards payments for rent, bond, credit cards, or other debt. It is also the way lenders measure your ability to manage the monthly payments for money you plan to borrow in future.
How to work out your debt-to-income ratio
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Add up all your monthly payment commitments, like school fees, rent, car payments etc. Discretionary expenses like groceries and entertainment are not included in this calculation.
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Divide this amount by your net monthly salary to get your debt-to-income ratio e.g. Debt R20 000 ÷ income R18 000 = 1.11. This means that for every rand earned, you have R1.11 rand of debt. Ideally, your income should be greater than your debt. For example: for every R10 you have R7 should be income and R3 should be debt. This would be a ratio of 7:3.
Strategies to deal with and to lower debt
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Put together a monthly budget.
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Find and identify the biggest amounts owed to your creditors.
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Contact your bank and creditors and arrange a payment agreement.
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Pay debts with the highest interest first.
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Pay your accounts on time.
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Decrease your impulsive or unplanned spending.
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Consider debt consolidation.
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Do a debt review or debt counselling frequently.
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Consider selling some of your assets to free up money.
- Beware of scams
Debt.
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Before you take on more debt, ask yourself
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Do I really need this item?
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How will buying it affect my savings plan?
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Have I budgeted for it?
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Can I afford the instalments now and in the future?
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How long will it take to repay the debt?
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What if I need something else while I am repaying this debt?
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How much interest will I pay? Is this interest calculated per month or per year?
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What if the interest rates increase? Will I be able to afford the higher repayments?
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What would it cost if I bought it for cash? How much cheaper would it be?
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If I really need it, can I buy it cheaper somewhere else?
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If I really need it, how much interest will I save if I pay it off over less time?
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How does the purchase help my long-term vision of wealth creation?
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What is my credit score? Don’t be scared to check your credit score. Yes, it will allow you to get any incorrect and outdated information on your profile changed. And no, it won’t enable lenders to track you down just because you checked. To access your information, download a credit score app or speak to your bank.
Credit facilities
1. Bank loan
A bank loan is a fixed amount for a fixed term with regular fixed repayments. The interest on a loan tends to be lower than an overdraft. You might be forced to take out life insurance to get the loan, which is an added expense. Make sure you understand the terms and conditions.
2. Loan overdraft
An extension of credit from your current account when the account reaches zero. An overdraft allows the individual to continue withdrawing money even if the account has no funds in it.
3. Home loan or bond
A home loan is a bank loan used to buy immovable property such as a house, using that property Every month you pay back a portion of the loan, with interest, over 20 or 30 years. A bond is finance borrowed against immovable property, using that property as security for the loan.
4. Vehicle finance
Vehicle finance is a type of bank loan used to buy a car. The interest rates are more favourable than ordinary loans. If you have an accident or your car is stolen, you would still need to repay the loan, unless you have insurance on the car. If you stop paying your loan, your car will be repossessed.
5. Hire purchase
This is an arrangement for buying expensive items, where the buyer makes an initial down payment and pays the balance, plus interest, in instalments over time. In this agreement, the item bought will only qualify to be taken home by the buyer once all the payments have been made.
6. Credit cards
Credit cards are a type of unsecured lending, which allows credit cardholders to borrow money to buy or pay for day-to-day goods and services.
7. Revolving credit
Similar to a credit card or other “line of credit”- revolving credit can be used and paid -off repeatedly , as long as the account remains open. It is automatically renewed every time the money borrowed is fully paid off.
