By: Herman Lombard, founder and executive director of financial service provider African Unity
South African consumers remain caught up in a cycle of heavy personal debt. This makes awareness around debt and all the issues that come with it important.
Experts say debt can be a useful financial tool – if it is managed correctly, and people should look out for ways in which they can make debt work for them.
Herman Lombard, founder and executive director of financial service provider African Unity, says that people, especially the youth, should learn to work with debt responsibly.
“There are different kinds of debt that can be incurred. There’s the good, the bad, and yes really, the ugly,” he explains. “It is vital that consumers know the difference.”
Good debt comes in the form of loans that allow consumers to turn an amount of money into something more. Examples of good debt include buying a property, taking out loans for home improvements, student loans or running a small business.
“It would probably take an eternity for ordinary people to save enough to buy a house cash, so the right loan will play a huge role in paving a positive way forward, Lombard says.
“Home renovations add value to your property, so it’s a good investment. A student loan allows you to get an education and increase your long-term earning potential, while a small business loan can help you set up or expand your business.”
Bad debt is debt incurred by acquiring consumable items that have a short lifespan. Clothing and retail accounts, dinners at restaurants, expensive holidays, other recreational activities, and expensive vehicles, which decrease in value the minute you drive out of the dealership, are all examples of this kind of debt.
Most credit card transactions are considered bad debt. Experts say that many credit card users start out being disciplined with their purchases but end up having to pay a huge amount of interest.
“You should look at what you can afford and limit your monthly spending to below that amount,” he advises. “You need to pay back the debt in full every month. A credit card can, however, become a useful financial tool for building a good credit rating if you can illustrate a good track record for settling your account on a monthly basis.”
The ugly part of debt surfaces when consumers end up paying shockingly high interest rates on loans, yet, have nothing to show for the money they have spent. Many become trapped as payments become higher. This is often the case when people make use of so called “loan sharks”, or “mashonisas”, who make good profit on providing loans at high interest rates of up to 50%, while their customers have no legal protection.
Reports show that a large number of South Africans make use of this informal service and consumers are advised to try to avoid falling into this kind of debt trap.
Debt collectors are considered to fall under the ugly part of debt. After many demands for payment, creditors often end up handing people over to debt collectors, who are often ruthless in their attempts to get them to pay. They are also known to buy creditors’ old debt, for cents and then pursue debtors to recover monies now owing to them.
Lombard has some tips for managing debt:
Be aware of how much is owed and to whom.
Pay accounts on time and never skip payments.
Draw up a monthly calendar for payments.
Commit to paying the minimum required.
Identify which debt is the most urgent to settle – usually it is the one with the highest interest rate.
Set up a budget for each month in a bid to control your spending.
Debt consolidation and debt review
Consumer acknowledging a need for help with debt when battling to make payments every month, is seen as a big step. Debt consolidation or going under debt review may have to be considered.
According to Karin Augustyn, a registered debt counsellor with Debt Hero (a division of Legal Hero (Pty) Ltd), all options should be considered carefully.
“Debt review is a formal process designed to help consumers restructure debt into an affordable repayment arrangement. It is also the first step towards relief for those who are over-indebted,” she adds.
Debt consolidation is a loan that covers the total amount of debt, in other words: all your debt. This allows for everything to be settled, leaving you with just one payment to settle per month, with one creditor.
Lombard concludes, “We should also adopt a culture of saving. So, while dealing with debt, it’s important for you not to continue accumulating it. If a rate cut does indeed become a reality, you should use it as an opportunity improve your situation.”
“Be conscious of the type and purpose of the debt you take on. Remember to protect your future self. The right amount of good debt can help you save for the future, without any bad debt,” he adds.