All debt is equal? Think again

Lesotho Times - - Property -

ALL debt is the same right? Not ex­actly.

This is ac­cord­ing to Adrian Goslett, Re­gional Direc­tor and CEO of RE/MAX of South­ern Africa, who says very of­ten con­sumers seem to put all debt in the same cat­e­gory, how­ever, while all debt is debt, it is not all equal.

“Iden­ti­fy­ing the dif­fer­ence be­tween bad debt and what could be con­sid­ered as po­ten­tially good debt will as­sist con­sumers to make more in­formed and bet­ter fi­nan­cial de­ci­sions mov­ing for­ward,” says Mr Goslett.

Be­fore the global prop­erty mar­ket down­turn, many home­own­ers would turn to their home eq­uity as a credit source when they re­quired large sums of money.

How­ever, post-re­ces­sion think­ing is some­what dif­fer­ent, with home­own­ers rather pay­ing down their home loan ac­counts as much as pos­si­ble to en­sure that they see a greater re­turn on their in­vest­ment should they de­cide to sell.

As a re­sult, a popular al­ter­na­tive would be for con­sumers to dip into their re­tire­ment funds and take por­tions of this money in cash when needed. Un­for­tu­nately, he says tak­ing money out of re­tire­ment in­vest­ments will only cost the con­sumer in the long run and have a detri­men­tal im­pact on their re­tire­ment in­come.

Mr Goslett says that in­stead of get­ting to the point of re­sort­ing to tak­ing away from a re­tire­ment fund, it is im­por­tant to un­der­stand the na­ture of the debt and see whether it will put the con­sumer in a bet­ter or worse posi­ton then they are cur­rently in.

“It is ex­tremely im­por­tant for a con­sumer to make the distinc­tion be­tween a good debt, a nec­es­sary debt and a bad one, as this will help to drive their de­ci­sion-mak­ing process.”

He says the de­ter­min­ing fac­tor be­tween a good and bad debt is that a good debt will re­sult in the con­sumer’s fi­nan­cial value grow­ing over time.

“A prime ex­am­ple of this is a bond, which re­sults in the con­sumer own­ing an as­set: a home.

“The prop­erty not only serves the con­sumer’s need for shel­ter, but also ap­pre­ci­ates in value and grows the con­sumer’s net worth over time,” says Mr Goslett.

“Some­thing to con­sider how­ever, is that a loan can tip over into be­com­ing a bad debt if the home­owner be­comes fi­nan­cially dis­tressed and can no longer af­ford their prop­erty.”

This em­pha­sises the im­por­tance of hav­ing a fi­nan­cial con­tin­gency plan in place when pur­chas­ing a home, he says.

A nec­es­sary debt would be some­thing that would change the con­sumer’s sta­tion in life, such as a stu­dent loan. In or­der to fund their ed­u­ca­tion, most stu­dents will re­quire some kind of loan.

While this means that they will start their ca­reer in debt, it will also pro­vide them with the op­por­tu­nity to earn a higher salary or pos­si­bly fast-track their ca­reer progress, he says.

An­other nec­es­sary loan for most would be car fi­nance, how­ever, this can also fall into the bad debt cat­e­gory if the buyer se­lects a car that is far too ex­pen­sive to run or main­tain.

Ac­cord­ing to Mr Goslett, any debt that is purely for con­sump­tion is bad debt, like hol­i­days, food or items of fur­ni­ture, for ex­am­ple.

“Th­ese kinds of items will not re­tain their value.

Tak­ing out a loan to pay for th­ese items is never a good idea, as it will only place more fi­nan­cial pres­sure on the con­sumer and put them in a worse off po­si­tion as they will end up pay­ing off th­ese items for months, or even years, with­out any fi­nan­cial re­turn,” says Mr Goslett.

He says re­gard­less of what cat­e­gory the debt falls into, ide­ally the sooner the debt is paid off, the bet­ter off the con­sumer will be.

“The fact is that debt ac­crues in­ter­est and the sooner it is paid off, the less in­ter­est a con­sumer will have to pay. More im­por­tantly, once all debt has been paid, a con­sumer has the free­dom to start sav­ing and build­ing a nest egg for them­selves,” says Mr Goslett.

— Prop­erty24

Con­sumers need to make the distinc­tion be­tween a good debt, a nec­es­sary debt and a bad one.

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