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After counting their R1 coins, the head of the One Rand Family household, Sbu, was shocked to see how much money his family spend on cars and credit-card debt each month.
The amount they owe and repay on their credit and store cards every month got him asking, “Why aren’t we putting that money to better use?” The family realised this debt amounts to more than one month’s worth of bond repayments and costs them a lot in interest. “Short-term debt costs the most but we keep paying the minimum amount,” Sbu says.
They may be enjoying the finer things in life right now, but at what cost to their future? This week we look at different types of debt.
Karin Muller, head of Growth Market Solutions at Sanlam Personal Finance, explains the differences between good, bad and ugly debt.
Good debt
Good debt improves your overall financial picture. Home or student loans are good examples. You might pay interest on a home loan but you can also make money if you sell this asset at a profit. And studying means you should be able to earn more in future. But make sure you can afford this kind of debt – even good debt can negatively affect your financial wellbeing.
Bad debt
Sometimes this type of debt is necessary, for instance when buying a car. It’s always better to pay cash but it’s not always possible. Keep bad debt as low as possible. Don’t buy a top-of-the-range car; rather buy a cheaper, second-hand or demo model. Make sure you understand the total implications of the contract and what you’ll be repaying in total – including any balloon payments.
Ugly debt
Buying things you can’t afford and don’t really need on credit is a common trap many South Africans fall into. We might buy a pair of leather boots or a big-screen TV on credit then spend months or years paying it back. In the end we pay far more for the boots than the actual cost because of the interest.
Top Tip: Take a five-minute break before making a purchase and ask yourself, “Why am I buying this? Is it to boost my ego, or will it add value to my life? How much will it really cost? Will I need to sacrifice something else?”
Do This: Instead of getting into debt, harness the power of saving through compound interest. This term means that you earn interest on interest. It allows your money to snowball (if it’s in a savings vehicle) or melt away (if you’re paying back debt).
Sanlam is a licensed financial services provider.
