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28 November 2014
Karin Muller, Head of Growth Market Solutions at Sanlam says that, sadly, for most people the instant thrill of a purchase far exceeds the delayed gratification prospects of saving. We often don’t stop to think about what that credit really costs.”
The National Credit Regulator (NCR) December 2013 figures, estimates that 20.29 million South Africans are in debt and that nearly half of these are struggling to repay this debt. This means most South Africans will spend their life paying back money they have borrowed. Throughout their lifetime, they’ll spend hundreds or even millions of rands on interest – money that could have seen them settling into an extremely good financial situation.
Muller says, contrary to what many people think, financial wealth has less to do with earning a lot of money and is more about managing money well, making clever investment decisions and avoiding bad debt.
She explains the importance of differentiating between ‘good’ and ‘bad’ debt: “Anything that will improve your overall financial picture – like a house, which is an asset increasing in value, or a student loan, which improves your future earning power, is good debt and is worth considering as long as it is paid back as fast as possible to reduce the interest payable.”
Muller argues that a life spent in debt can be equated to ‘self-robbery’. “People are often deceived into buying on credit to fulfil their immediate desires and they overlook the true cost of debt, the staggering amount of interest paid on money borrowed and the admin and service fees associated with being in debt.”
Sanlam recently evaluated the true cost of some of the most common types of debt in South Africa. A typical handbag bought for R550 on a store card and paid off over 12 months would, in fact, cost the buyer around R891 (R59 in interest and R282 in admin fees). For R891, that person could have bought a far nicer bag. The same applies to a TV purchased on a credit card for R15 000. It would cost about R18 996 after interest and fees. And a car with a market value of R172 533 and paid off over four years, would cost about R47 227 more once interest and fees had been paid. This amount would be even more with balloon payments and where longer terms applied.
“So if this was a picture of one person’s debt, interest and fees on these three purchases alone would amount to R51 564. If you asked the same individual to hand this amount of money over to a large banking or retail institution they would be horrified. But, that’s pretty much exactly what they are doing.”
Muller says a very different result would emerge if the same amount of money was invested in a suitable investment product for the same period – like a unit trust or policy. “If someone invested a lump sum of R51 564 at an annual rate of return of 8%, they would, at the end of the period, have R278 456! Most of us won’t have this lump sum to invest, but if we invested R1 000 a month for those five years, we’d have R73 414, having earned R13 414 in interest. And if we kept this going for 10 years at 9% per annum, we would have earned R71 086 in interest and would have saved a total of R191 086,” says Muller.
Vangile Makwakwa, author and financial expert, warns that people need to observe the emotions that come up whenever they feel the need to spend or when they budget as these emotions impact their behaviour. She adds that: “Most of us access credit because it is there, because it is easy and because we’ll get stuff quickly. It is actually a lot easier to opt in than to opt out of buying on credit. In our parent’s day the attitude was very different. People really knew the value of money and they respected it and avoided debt at all costs.”
She believes one of the best ways to avoid becoming a debt ‘victim’ is to get to grips with each and every one of your expenses, including interest and fees. “Sanlam recently conducted a very interesting social experiment called the One Rand Man, where an ordinary Capetonian agreed to live his life using only R1 coins for the month of July. It was clear just how far removed he’d become from his money. In a typical month the One Rand Man would spend his full salary and slip into overdraft on his credit card. The true value of money only became clear to him when he had to account for every penny.
“When it comes to credit, my tip to people is this: Start to keep track of each and every expense. Find out exactly how much you are paying in interest on your credit card and store cards, and itemise this. And then picture all the things you could do with this money if you still had it in hand.”