How to tackle debt


South African consumers are under increasing financial pressure due to high unemployment and increases in living expenses such as for transport, utility bills, food and the VAT rate.

As a result it has become a challenge to manage and pay off debt.

Data from the National Credit Regulator (NCR) shows that total consumer credit was R1.71tr at the end of March last year, up from R1.66tr in 2016.

This is equal to more than 40% of South Africa’s GDP. The 14 registered credit bureaus have records for almost 25m credit-active consumers, with nearly 40% of consumers having “impaired records”, according to the NCR's 2017 annual report. 

In 2016, there were nearly 24m credit-active consumers, of whom 40% had “impaired records”.

Most people fall into a debt spiral because of unforeseen circumstances. This, warns the NCR, may include medical expenses, a divorce, losing one’s job, not saving enough or income not keeping up with increased costs.

Then there are some “foreseen circumstances” that can be avoided, but often are not. These include uncontrolled gambling habits and poor money management, the regulator says.

Reinhard Pettenburger, CEO of Debt Therapy and chairman of the Debt  Counsellors Association of South Africa in the Western Cape, says clients who have managed to keep up with their renegotiated debt repayments for many years are now struggling to maintain their monthly instalments in debt review.

He says his firm has had to renegotiate some of the agreements with banks because people are simply unable to make ends meet.

Below, a number of experts provide advice on how to manage and pay off your debt, and what to do when you’re in over your head.

How much debt can you handle?

Niel Fourie, the public policy actuary at the Actuarial Society of South Africa, says there are some general rules of thumb to determine how much debt one can take on.

Although the decisions may vary from person to person, he advises people not to spend more than 30% of their income on a mortgage bond, as this is generally the largest chunk of household debt.

“It is important to draft an honest budget and carefully look at your current spending patterns and what your current income is,” he says.

Fourie advises that one allows for an “expense buffer” for unforeseen expenditure such as medical expenses or a car that breaks down or gets stolen.

The minute you find that you are unable to service your debt, the trouble starts. If you are in the unfortunate position of having to sell your house at short notice, you might find yourself being in an even worse situation.

For example, in the financial crisis of 2007/08, many people were forced to sell their homes. But because of market conditions at the time, many consumers still had outstanding debts, even after selling their homes.

Honest budgeting is also important,  because many credit providers still offer more credit than what people can afford.

“Do not fall into the trap of buying things you do not need to impress people you do not even know,” says Fourie.

Good debt versus bad debt

Debt is normally considered “good” when you use it to obtain an asset that increases in value over time or has “income-producing capacity”, explains Fourie.

A study loan (income-producing capacity) or a mortgage bond on a property (increased value) is generally considered good debt.

Some people consider vehicle financing “good debt” if it has income-producing capacity, but Fourie is not convinced. Because a car depreciates in value, this kind of debt cannot really be considered good, he argues.

“Anything where you have to finance spending, such as short-term loans for a holiday, or for clothes, is considered bad debt. If you start using loans and credit cards to fund your lifestyle, you are on a treacherous path.

It might lead to a debt spiral. That is a difficult space to be in,” warns Fourie.

South African urban households seem to have lost some of their appetite for personal loans.

The 2017 Old Mutual Savings and Investment Monitor, released in July last year, shows that the number of people from working metropolitan households who took out personal loans from financial institutions dropped from 21% in 2016 to 14% last year.

The portion of income used to service debt remained the same, at 16%.

Garnet Jensen, senior director at TransUnion, says the type of debt in a consumer’s portfolio is a very important consideration.

Debt can be broadly broken down into secured and unsecured debt. Secured debt 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 debt repayments over time, the lender can seize the asset and sell it to recoup their money,” he explains.

The interest rate on this type of debt depends largely on the credit rating of an individual; the more creditworthy a person is, the lower the interest charged.

Unsecured debt, such as credit cards and personal loans, does not have the backing of assets to serve as collateral: “If the borrower defaults, the credit providers have to implement legal action, which can be lengthy and expensive with no guarantee of success.

Jensen says this type of debt usually comes with a higher interest rate to ameliorate the risk of the loan.

If people have more unsecured debt in their portfolio, they are classified as “high risk” when applying for more credit.

“Credit providers are compelled by the National Credit Act [NCA] to perform affordability assessments when granting or extending credit and the act has certain minimum prescriptions in this regard,” Jensen explains.

Not only is the consumer’s credit report and credit score taken into account in the assessment, the debt-to-income ratio is also considered, as well as the credit provider’s ability to collect the debt in terms of the debt-to-asset ratio.

Consumers can determine their debt-to-asset ratio by dividing their total debt by their total assets.

Simply put, this ratio shows how many of one’s assets one will have to sell to cover the cost of the debt.

“The right ratio is more complex to determine, as it depends on a number of factors like the type of debt and life stage of the individual,” says Jensen.

However, if your debt is significantly higher than the value of your assets, you will be considered a risk to creditors.

Soré Cloete, senior legal manager at Old Mutual Personal Finance, says consumers should avoid using credit on “unnecessary items” and instead pay cash if they can afford it.

“Close unused credit accounts that are fully paid. Forgotten retail debt can have a negative impact on your credit record. Also avoid using one credit card to pay off another credit card.

This is not paying off debt. It is merely delaying repayment and attracting more interest,” Cloete says.

Fourie notes that although there is a cap on the minimum and maximum interest rates credit providers are allowed to charge, these institutions still find ways of making money.

Many try to make up the “interest cap” by charging more for insurance or upping management fees.

There are several measures available to consumers who have fallen into a debt spiral. But ignoring the matter is not one of them.

Getting out of a debt spiral

If you have additional funds available and are looking to pay off your debt sooner, you should aim to first pay off the debt that carries the highest interest rate, says Jensen.

This is unsecured debt such as credit cards and personal loans. Many store cards, such as clothing accounts, for example, have interest-free credit windows.

Try to pay off the total bill within this period to avoid interest charges.

“Do not spend more on the card before you have paid off the total, and avoid extending your payment period,” advises Jensen.

Cloete says it is advantageous for consumers to pay more than their monthly instalment amount.

This will reflect positively on their payment history.

Consolidating debt

Consolidating one’s debt offers consumers the opportunity to take out one large loan to cover several smaller loans – it simply means that all your debts are consolidated into one lump sum, says Jensen.

“It might sound counter-intuitive, but if used wisely, consolidation can be an effective way to get yourself out of unmanageable debt.”

Consolidated loans are usually longer-term loans that come at a lower overall interest rate and have lower monthly instalments.

However, because they are longer-term loans, it may mean consumers end up paying more.

Furthermore, Pettenburger warns, consolidation loans only work if the consumer is truly disciplined.

Many use the loan to pay off credit-card debt, but immediately start using the credit card once the debt has been paid.

“Then they need another consolidation loan to pay the card. The debt spiral gets so out of control that nobody wants to lend them money anymore,” he says.

Consumers may also consider consolidating their debt under their existing home loan. This is applicable to people whose outstanding loans are less than the value of the property.

The consumer may be able to secure a loan against their home and consolidate all their unsecured debt into one facility.

All the debt will then attract an interest rate of around 10% compared to having interest rates of up to 27%, which is the maximum interest rate on personal short-term loans.

But Fourie warns: “It is, however, important to look at the term and interest rate of the new home loan when considering this option.”

Debt review

Debt review is a legal process that was introduced with the NCA. It allows over-indebted consumers to hang on to their assets and protect themselves from legal action by creditors.

Jensen says that when entering into debt review, a person allows a debt counsellor to obtain a court order on their behalf and to draw up a manageable repayment plan. The counsellor will liaise with creditors to renegotiate payment at lower interest rates. (See sidebar.)

Paying debt versus saving

Very few investments offer or guarantee a return of 17% or more. However, interest rates on personal loans and credit cards range from 17% to 27%.

Consumers who have personal loans or credit card debt would be wise to first pay off these debts before starting to save, says Fourie.

“The question becomes more difficult if you have a home loan with an interest rate of, say, 10%, where there are investments where you can make a higher return.”

He says an option is to continue with the monthly bond payments and invest in another asset class.

“The question is easier in terms of the short-term personal loans. The repayment of short-term expensive debt is a ‘no-brainer’,” says Fourie.

This article originally appeared in the 10 May edition of finweek. Buy and download the magazine here, or sign up for our weekly newsletter here.

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