Money

How to make smart de­ci­sions about debt

DRUM - - Contents -

DEBT is a ma­jor cause of fi­nan­cial stress. A to­tal of 64% of par­tic­i­pants in Old Mu­tual’s Sav­ings and In­vest­ment Mon­i­tor in­di­cated that their stress lev­els are over­whelm­ing be­cause they have too much debt and are strug­gling to man­age it. Be­fore tak­ing out any kind of loan, you should con­sider whether you can re­ally af­ford it and whether it’s worth the money and the stress. Be hon­est with your­self when an­swer­ing the fol­low­ing ques­tions.

1 CAN I AF­FORD IT?

Be­fore buy­ing an ­ex­pen­sive item on credit or tak­ing out a loan you need to work out if you’ll be able to make the pay­ments. Cal­cu­late this by sub­tract­ing all your ex­ist­ing ex­penses from your in­come.

Your bank state­ments are a clear record of your in­come and ex­penses. Your start­ing point should be your in­come af­ter your em­ployer has sub­tracted tax and other ex­penses, such as your pen­sion con­tri­bu­tion. Take into ac­count all cur­rent ex­penses – from rent, petrol and gro­cery money to help­ing a fam­ily mem­ber with school fees. Also in­clude emer­gency ex­penses, such as med­i­cal costs.

The sum is your monthly in­come mi­nus your monthly ex­penses = how much you’ll be able to pay off monthly. The an­swer to this sum should com­fort­ably cover the debt amount.

WHAT IF I SAVE 2 FOR WHAT I WANT IN­STEAD?

Some peo­ple be­lieve it’s more ­af­ford­able to buy some­thing on credit be­cause the monthly re­pay­ments look like smaller amounts com­pared to pay­ing a large, once-off amount. This isn’t true. It’s al­ways cheaper to buy cash be­cause you won’t be pay­ing in­ter­est.

An­drew Dav­i­son of Old Mu­tual Corporate Con­sul­tants gives this ex­am­ple: you’ve de­cided to buy a lounge suite for R25 000. If you take out a loan over 36 months at an in­ter­est rate of 18% you’ll pay just more than R900 a month. You’ll re­ceive the lounge suite ­im­me­di­ately but end up pay­ing R32 400 for it over three years. Of this, R7 400 is in­ter­est.

But if you’re able to de­lay grat­i­fi­ca­tion and save the R900 ev­ery month, you should be able to save up R25 000 in less than three years.

You will also be sav­ing a lot of money be­cause you won’t be pay­ing all that in­ter­est.

WILL IT EN­HANCE 3 MY LIFE OR WILL IT DE­VALUE OVER TIME?

Not all debt is bad. Good debt is some­thing that will add value to your life over time, such as a stu­dent loan or when you buy prop­erty that ap­pre­ci­ates in value – pro­vided you can af­ford the bond.

Bad debt is any­thing you can’t af­ford and that doesn’t ap­pre­ci­ate in value over time, such as a car loan. Good debt is only pos­i­tive if you’re able to pay it off con­sis­tently. If you fall be­hind on pay­ments or you take out a stu­dent loan but end up par­ty­ing your time away and fail­ing ev­ery sub­ject, it cer­tainly won’t be to your ad­van­tage.

4 WHO IS IT FOR?

Be care­ful not to take out a loan be­cause a friend or fam­ily mem­ber wants to use the money. If you fall be­hind on pay­ments, you’ll be the one who’s branded a bad debtor, not them.

Set and stick to clear bound­aries as to what they can ex­pect from you so that you can pre­vent false ex­pec­ta­tions and neg­a­tive at­ti­tudes. You can sug­gest they see a fi­nan­cial ad­viser who can help them draw up their own fi­nan­cial plan.

Think re­ally care­fully be­fore sign­ing surety for someone else’s loan. Ex­perts say many con­tracts of guar­an­tee con­tain fine print that’s usu­ally much more de­tailed than most peo­ple re­alise.

For ex­am­ple, it could mean that if you take a loan and de­fault on even one pay­ment the cred­i­tor might legally be able to con­fis­cate some of your as­sets. And once you’ve signed a con­tract of guar­an­tee, you can’t change your mind.

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