How to manage your debt for a better future
The average South African is indebted, many at a critical level, and any interest paid on money borrowed today has an impact on your future. But there are ways to manage the situation, says Mark Hawes, Certified Financial Planner at Alexander Forbes.
Firstly, understand exactly what debt is and why you should manage it. Debt is your money from tomorrow. The problem is that when you get to tomorrow, you’ve already spent it.
If you buy an apple today on credit, you haven’t paid yet. Great - or is it? The result is that, come next month you will pay for it, plus interest. The problem is that when you do actually pay for it, for more than you bought it for, you don’t get an apple, because you have already eaten it.
Consequently, you pay more in the future and have less money available to be able to buy additional food in this example. This is the fundamental mechanism of how we end up living beyond our means. Therefore, basic monthly consumption should not be paid for with credit. Large assets possibly yes, but not daily expenses like groceries. In addition, all debt, including houses and cars, should be settled and paid for by the time we retire – or sooner.
It might sound like a monumental task, but there are strategies to manage your future financial security. So how do we get out of debt – and stay out of debt?
Step 1: The best place to start is where you are, with what you have.
Find out the details of all your debt; the settlement amount not the balance; the interest rate in percentage not just rands and the monthly instalment in rands. This will help you to compare loans as to which one is the most expensive. Remember just because the debit order may not be very big, your interest compared to your original loan may well be. For example, the instalments on a housing loan are generally the largest debit order in (nominal) rand value, but the cheapest in interest rate rand value.
Step 2: Take control
Pay your smallest debt off first. With all the pressures on our income it’s very important to build momentum. The best way to do this is to actually see fewer and fewer debit orders coming off your bank account. This will help you to maintain the course to getting out of debt and staying out of debt.
Step 3: Pay yourself first.
After each debt has been settled your cash flow should improve. In order to sustainably pay off debt permanently, you need to feel your cash flow improve as a direct result of your efforts. So keep 10% of the cumulative premium you were paying for yourself. The balance can be paid to the rest of your debts to pay them off – unless you are under debt review and are legally obliged to.
Step 4: Emergencies will happen.
The secret to staying out of debt is savings. With each debt that is settled, it is a prudent approach to take at least 20% of the instalment and put it aside in savings for emergencies. This will prevent you from going back into debt to the same extent when things don’t according to plan.
Step 5: Get rid of expenses you don’t need.
Go through your budget and decide if each debit order, whether it is a policy or present, improves your cash flow and future over the next 12 months or not.
We can therefore conclude that:
- Debt is the problem, not the solution.
- Your financial well-being is within your control if you take full responsibility for achieving it.
- It will take time.
- Stack up the small victories to maintain the stamina.
- Improving your cash flow will afford you more resources for an improved lifestyle in the next 12 months.
Ultimately you don’t want to just stop the pain of yesterday’s overspending, but focus on improving your lifestyle and ability to spend in your future. You want to be able to face retirement without the cloud of debt and stress spoiling your plans.
Be the solution you have been waiting for.