How can we manage financial dues better in our personal lives?
Many people don’t understand debt, don’t understand interest rates and how it affects them and their repayments. A simple yet powerful way to look at your personal debt is that we all have income and expenses. Often people live beyond their means, and we then find ourselves in debt. In these cases, our expenses surpass our income, and people often use credit cards and loans to uphold these living standards.
Many people don’t understand debt, don’t understand interest rates and how it affects them and their repayments. A simple yet powerful way to look at your personal debt is that we all have income and expenses. Often people live beyond their means, and we then find ourselves in debt. In these cases, our expenses surpass our income, and people often use credit cards and loans to uphold these living standards.
Then, interest rates come into play and this creates another level of confusion.
Let’s start at an easy baseline. You know what your income and expenses are and how this should be paid. Logically we should have a bit more money available in terms of planning to keep ourselves out of debt.6
One of the biggest issues when consulting with low to mid-tier net worth clients, is their continual habit of pushing their budgets straight up to their income levels, and then every now and again when they encounter unplanned expenses, they get caught with their pants around their ankles. It is clear that this is not just a topic for people in the lower-income brackets. Personal debt is a habit, people don’t quite understand how to budget. The only way to manage this is to work according to your budget, save regularly, save what is left over at the end of the month for those curveballs in life and not go into debt.
Don’t spend the extra money you have left, rather first save it.
Making provision through saving is important. Provide for retirement, and save at least 10 % of our income in an emergency fund for our long-term goals. We will expand on this in a future blog.
Non-bank loans
Non-bank loans are typically retail loans e.g. a Pep account, Edgars account, Tools accounts. These bear high interest, some as close to 24,5 %.
Personal loans are typically loans from banks. Your risk profile gets considered and the bank assigns an interest rate to you. This could range from 7 – 22 %, according to your risk profile.
Your risk profile indicates the chances of you defaulting on your loan. The riskier you become, the higher the rate becomes and when you have a poor risk profile, you’ll probably end up paying 17 % interest on a personal loan which is also extremely high.
Credit card costs range between 7 – 17 % and are set up according to your risk profile, your income and expenses.
When you weigh up your options to decide which loan to pay off first, start with the loan with the highest interest rate as a rule of thumb. Some individuals may prefer paying off a smaller loan first, just to get a feeling of accomplishment and then move on to their bigger loans. This is a matter of personal preference.
However, if you have two loans of R100,000 and one with 24 % interest and the other with 27 % interest, the rule of thumb is to pay off the loan with the highest interest rate first.
Minimum Payments On Credit Cards vs Paying Off Your Credit Card Loan
On your credit card statement, you will find a minimum amount due. You have to pay a higher amount to pay off the loan on your credit card and be diligent not to spend additional money on your credit card. Often when you pay the minimum amount payable on a credit card, you are merely paying off the interest on the loan, you are not even paying off the capital.
I often interact with people who are frustrated as they have R5,000 credit card debt and think that paying R200 for 25 installments will settle the credit card debt. However, in many instances, they are only paying off the interest on the credit card debt.
To settle credit card debt, more than the minimum payable amount needs to be paid monthly and no additional items should be bought on the credit card.
The First Step In Getting Out Of Debt
Plan a goal date for settling your credit card debt. It is important to set up a payment plan for your credit card debt, pay off more than the minimum amount and not spend any additional money on your credit card. Find a way to move your budget, pay less and be open to suggestions. Sometimes we need to take a knock in terms of personal spending or luxuries that we are used to. Just consider the advice from some of the wealthiest entrepreneurs. They plan first and spend on luxury last. Warren Buffet, still lives in the same house that he has had for many years, and he drives the same car.
In South Africa, our problem seems to be that we want to keep up with the Joneses and our egos get in the way. Many individuals do not have the guts to downgrade their lifestyle or just to stop buying more and driving their living standard higher. The first step in getting out of debt is about being honest with yourself and considering how you are going to settle your debt.
There are basically two types of interest rates that exist: Fixed and variable interest rates.
Interest rates follow the repo rate that the South African reserve bank gives. The current repo rate is 3.5 %. The prime interest rate is at 7 % and this is the lowest that it has been in about 16 years. These are both variable rates. As the rates of interest go up and down, so your payments will go up and down. If, for example, the prime rate increases to 8 %, your repayments on your loans will also increase.
You can get a fixed interest rate at a higher rate than the variable interest rate. If you buy a car at 7 % now you can set a fixed interest rate at 7.5 % and plan exactly how much you will pay monthly over the next 5 years. You will pay more in the short term when the interest rate remains lower than your fixed rate, however, especially in South Africa, where the interest rates are more volatile compared to other more stable economies, you can expect an increase in the interest rate towards the end of 2021 toward 2022 and 2023. Therefore, you will save on your overall loan repayments at a fixed interest rate in all likelihood.
Should you keep a variable interest rate, your payments will increase as the interest rate goes up.
Variable interest rates are favourable at the moment, which creates a problem as individuals would maybe buy a property they can afford now at 7% but would not be able to afford the property at, say 8%. Let’s say a R 2 mil property, at the current prime interest rate, can be bought at a monthly repayment of R16,700. As soon as the interest rate increases, the monthly repayments increase and now the repayments are out of their budget.
When the interest rates are very high, I would suggest considering a variable rate. However, with the current low interest rates, I would strongly recommend a fixed interest rate.
Variable interest rates are not in your control.
Your consideration to work with a fixed or variable interest rate will come down to personal preference and your appetite for risk.
My current recommendation on the lower interest rate is to fix the interest rate when applying for a bond or car finance now as the interest rates will be higher in one or two year’s time.
Practical Tips For Buying A Home
If you buy a house for R2 mil at an 8 % interest rate over 20 years. The current repayment is in the range of R16,700 per month as a bond repayment. The total repayment over the 20 years will be R4 mil, the interest that you will pay is just over R2 mil. You will pay R2 mil for your home and R2 mil on interest. If you add 10 % on your repayment, an additional R1,700 per month, the repayment goes down to R3,5 mil and the total interest saved is R340,000 just by adding 10 %. You will pay off the property in 16 years and 2 months. Every time you pay additional money on your monthly instalments, you decrease the capital amount.
Consider this example: If you can afford a R 2mil house. Consider buying a home for R1,6 mil and pay an additional R1,700 per month, you will end up paying 12,5 years and you will have an asset in almost half the time. By buying a slightly less expensive property, you are paying it off faster and have an asset faster. By paying your property off sooner, you will be able to consider proper wealth planning.
Final Thoughts
Set a goal to get out of debt. Know what your income and expenses are. Work according to a budget and stay within your budget. Have money in an emergency savings fund by saving 10 % of your monthly income for the curveballs in life. Pay off the loan with the highest interest rate first. Understand fixed and variable interest rates and fix interest rates where it logically makes sense to save you money in the long run. In paying minimum payments on e.g. your credit card, you will keep paying off interest and you won’t decrease the capital amount of the loan. When buying a house, considering buying a house that is less than the maximum amount that you can afford and pay 10 % more every month on your instalments. You could pay off the asset in half of the time and save a large amount of money on merely paying off interest.
If you have personal debt and you are serious about getting out of debt, connect with Francois le Clus to support you in setting up a plan to pay off your personal debt.
