This week, the One Rand Man tweeted a photograph of piles of R1 coins representing his expenses relative to each other. It reveals that his biggest monthly expense, apart from what he pays the taxman, is his car repayment and his fifth biggest is credit.
As part of his focus on getting in touch with his money and where it goes every month, the One Rand Man needs to do a better analysis of what he spends on credit and just how much it is costing him over the long term.
Both his car and credit repayments include the cost of credit and the repayment of the cost of the items he bought.
He is paying off two clothing accounts. One of these accounts he took out less than six months ago, so it is not currently attracting interest. On the other, he is paying about 20 percent a year in interest.
He is also paying off credit card debt, a bank overdraft and a student loan.
Your credit card debt, if not paid off at the end of the initial interest-free period (normally 55 days), can attract interest of up to 22.65 percent. A bank overdraft can attract 22.65 percent, and a student loan is usually linked to prime plus anything up to six percent, depending on your risk profile.
On his car loan, the One Rand Man is paying 12.25 percent – prime plus three percent.
When you buy an item on credit it costs a lot more than when you pay for it upfront, and you should always take note of the cash price and the price you will pay for the item on credit – the cost of the credit.
If you enter into a credit agreement, your quote should show the cost of the principal debt – the amount you are borrowing for the item you are buying – the interest rate you will be charged, any other credit costs such as an initiation fee, and the total cost of the agreement.
The difference between the cash cost of the item and the cost of your total credit agreement includes not only interest, but interest on interest – the cost of compounding interest working against you when you borrow.
German physicist Albert Einstein said compound interest was the eighth wonder of the world, because you earn interest on the money you save and interest on the interest. He said those who understand compound interest earn it; those who don’t, pay it.
If you, like the One Rand Man, have credit on which you are paying interest, you are paying compound interest to a credit provider or bank.
And other charges included in the credit agreement can result in the credit costing double the quoted rate, Niel Fourie, Public Policy Actuary at the Actuarial Society of South Africa, says.
The additional charges include a once-off credit initiation fee, a monthly premium for compulsory credit life insurance, and a monthly service fee. On top of this, you must pay VAT of 14 percent on these charges.
Last year, Fourie did a survey of the credit offerings of several large retail stores that showed that if you spend R5 000 on credit today, you may end up repaying anything between R6 200 and R9 000 by the time your debt is repaid over 24 months.
He says buying on credit should be avoided unless it is for a home.
Saving up for an item and paying cash for it means delayed gratification. But while you save, you earn interest on interest – your money works for you rather than against you, as it does when you buy on credit.
A credit card can be a useful tool if used wisely and responsibly. This involves paying off all debt within the interest-free period, if this applies to your account.
The budget facility that allows you to repay your credit card debt – typically over six to 60 months – should be avoided at all cost, Fourie says.
He gives this example of credit card interest. If you spend R10 000 on your credit card and your interest rate is 22 percent, your monthly payment will be around R510 a month if you make use of a two-year budget facility. You will incur a total of R2 240 in interest charges.
If, on the other hand, you delay your purchase by two years, and save R510 a month in an investment with a five-percent return, at the end of the two years you would have R12 820, with R580 being the interest you earn for doing nothing other than waiting.
This week, the One Rand Man also tweeted that “budget or not, a man needs his coffee” with a photo of the take-out coffee and the R1 coins needed to pay for it.
If he is serious about considering where his rands go, he should consider a video released by Nedgroup Investments this week. It shows that if you saved R20 spent on a cup of coffee every day, you could save R36 500 over five years, and if that saving earned six percent interest compounded monthly, at the end of the five years you would have R42 443.
Nedbank says this simple example shows the benefits of being disciplined about saving.