Good vs bad debt – find out the difference

Image: Getty Images
Image: Getty Images

Many South Africans struggle to make ends meet and turn to credit to finance their day-to-day needs, leading to the misuse of credit. This is evidenced by the household debt-to-disposable income ratio of 72.6% in the second quarter of 2017 - a significant jump from 54.1% in 2000.

According to Vera Nagtegaal, Executive Head of Hippo, while credit can be an empowering tool, financial literacy plays a big role in understanding how it makes one’s life easier. “The impact that a lack of financial literacy contributes to the shocking debt numbers can’t be ignored.”

She explains that we should empower ourselves with the knowledge that can help us to differentiate between good debt and bad debt. Not all debt is bad, for instance good debt is the type of debt that will pay off in the long run. It can be a home loan or student loan. You anticipate that the gains you’ll make in the future will make up for the cost of the house or qualification.

There are different forms of bad debt, like living a trendy lifestyle that is out of your budget and constantly maxing out your credit cards to keep up.

Nagtegaal gives us pointers below on how you can manage your debt and how debt can affect your insurance.

Managing the debt

Nagtegaal says that some people can find themselves so deep in the debt trap that keeping up with monthly obligations becomes overwhelming. “The first thing you should consider doing is to speak to your creditors and make a suitable payment arrangement.”

For some, this may not be a viable option and turning to consolidation loans may ease the pressure. This could provide respite in the short term but can end up being more expensive in the long-term.

“The other danger with consolidating debt is that you might be tempted to open new accounts, or start using again paid up accounts – which would begin yet another cycle of indebtedness,” cautions Nagtegaal.

The impact of debt on insurance

What many people who go under debt review are not aware of is that this process could also affect their insurance premiums, Nagtegaal points out. “Your insurance premium is calculated based on your risk profile as well as your adherence to financial commitments. A change in your financial situation alters your risk profile.”

Some insurance companies do not pay out if you fail to notify them that you’re undergoing debt counselling, which makes it essential for consumers to alert them as soon as they start this process.

Nagtegaal says this change may affect your premiums, but it’s best to be open and upfront with your insurers. “In most cases, insurers can look at alternative cover options to lower the premiums, such as removing certain benefits or customizing the cover applicable to their current needs, in order for individuals to manage their financial risks.”

This year if you in bad debt try to minimise spending and get all your payments in order so you can start accumulating the good debt.

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