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Debt is a major cause of financial stress.
A total of 64% of participants in Old Mutual’s Savings and
Investment Monitor indicated 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 these questions.
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.
Remember to take into account all current expenses – from
rent, petrol, savings and grocery money to, for instance, helping a family
member with school fees.
Also take into account 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 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’ll also save a lot of money because you won’t be paying
all that interest.
Will it enhance 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 which 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 take out a student loan
but end up partying your time away and failing every subject, it certainly
won’t be to your advantage.
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
friends and family can expect from you. That way 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 instance, it could mean that if the person taking the
loan defaults on even one payment the creditor might legally be able to confiscate
some of your assets. Once you’ve signed a contract of guarantee you can’t change
your mind.
Tip: One way to
find if you’ll be able to honour a loan is to calculate whether you’d still be
able to make the payments should the interest rate rise by 1-2%
