“The following checklist could be useful in improving your personal financial situation.”
The best investment that the average income earner in South Africa can make is to reduce any debt that s/he may have and most of us have mountains of it. The return on this investment will be in excess of thirty per cent on credit card debt, for example, and that return is tax-free! Fund managers who’ve achieved this rate of return for their clients during the past year are very few and far between.
Janet Heard produced an excellent article on personal finance in the Business Times of 1 October this year. She quoted statistics from the Reserve Bank, which indicates that almost 57% of after-tax disposable income of all households in the country is allocated towards debt repayments. Most South Africans have home loans, vehicle loans, credit cards and clothes and furniture on credit. Many households have study loans and bank overdrafts as well.
Prime interest rates peaked at 25.5% at the end of 1998. Whereas actual interest rates on housing loans are normally close to the prime rate, the rates paid by customers on furniture or clothing instalments were as high as 6.5% above prime. This meant that only the interest component of this debt, before repayment of the article itself, was a punishing 32% in many cases. The prime interest rate has now dropped to 14.5%, but the rate paid by customers on any outstanding credit card amount is still 22% or more.
South Africans are, therefore, allocating a major chunk of their income to interest. This adds no value to the product. It simply means that you get to use the product before you can afford to pay the full price, but at a considerable additional cost. Your income is, therefore, no longer yours to dispose of as you wish, because more than half goes towards debt redemption. It should be kept in mind that banks, furniture and clothing stores are constantly trying to improve their profits. One of their strategies to achieve this is to offer loans and credit to customers as if it were the right thing for the customer to do. In many cases, it is not. Customers should make this decision for themselves in terms of their own affordability levels.
Households are, therefore, well advised to plan before they make any large expenditure commitments on credit. The following checklist could be useful in improving your personal financial situation.
This analysis applies equally to cars and furniture and the converse also applies when repayments are not honoured. The interest cost of credit transactions increases exponentially when due dates are missed. Banks do not charge interest on credit card purchases (except for fuel) until the due date on your statement. However, if the due date is missed, even by one day only, then interest of at least 22% for a full month is due immediately.
Live within your means. Financial disaster is invited when you persistently spend more than what you earn. In order to avoid this, it’s wise to prepare a basic budget of all your expenditure items and their costs. Make sure that the cost of these items doesn’t exceed your income or increase your income if you can.
Plan, shop around and negotiate your credit purchases. A conscious decision should be taken whether or not a credit purchase is really essential at a particular point in time. Postpone the acquisition until you’ve saved at least half of the purchase price. You’ll then be in a position to negotiate a discount and a better interest rate. The more cash you have the better the discount that you can request. This can be as high as thirty per cent on selected transactions.
It’s also advisable to shop around. Some suppliers offer better prices while others offer better interest rates. Others may even offer you both. The customer should make sure that s/he understands what the total price of the item will eventually be, including interest. The total cost of a house of R150,000.00 over a twenty-year mortgage period, for example, could be R461,000.00, which is more than three times the original cost.
Try to negotiate a credit transaction that offers the opportunity to reduce interest costs for repayments that are higher than the monthly instalment.
Accelerate repayments on credit transactions. Interest costs can be substantially reduced when you accelerate your repayments. As indicated above, the interest cost of a R150,000.00 house will amount to R311,000.00 over twenty years at the standard instalment repayment rate of R1,920.00 per month. By increasing the instalment with only R100.00 per month, the interest cost can be reduced by R75,000.00.
In summary, the credit worthy customer with cash in his hand and who shops around for the best deal, is likely to pay far less in terms of both price and interest cost for the same item than the person who buys indiscriminately on credit. Avoid incurring new debt unless it’s absolutely necessary, because interest costs are very expensive. You should also avoid missing the due dates of any existing instalments. Accelerated repayments may increase your hardship in the short-term, but in the long run, it’s the most economical way to get yourself out of debt and it’s likely to be the best investment that you’ll ever make.
Glen Steyn holds a Masters degree from the University of South Africa (UNISA) in Development Economics and Strategic Management. Glen founded an economics and consulting firm in September 1996. He has conducted various assignments, including the Limpopo Province Economic Development Strategy, Limpopo Province Spatial Strategy, economic information for district development planning, demarcation of municipal boundaries, land development objectives, local economic development, economic impact and market studies and strategic management.
Glen is requested to lecture on economics and strategic management on a regular basis and is frequently invited to do presentations on the provincial economy.