By Joseph Phiri
South Africa’s well-developed financial system has led to increased access to credit. While this supports economic growth, overextension by households can have unintended negative consequences.
When used correctly, credit help households in accumulating assets. However, overused credit can be detrimental and lead to:
- pressure on disposable household income
- lower saving
- the risk of retiring to an uncomfortable retirement
Three-quarters of take-home pay is spent on debt
Debt to disposable income for South African households has increased from less than 60% before 1994 to the current level of around 75%, which is higher than the long-term average of 70% according to the South African Reserve Bank (SARB). This means that households spend three-quarters of their take-home pay on debt and only has a quarter of their salary to spend on everything else. This worsens if the interest rates increase and the cost of paying the debt rises.
These figures exclude loans from informal credit sources such a loan sharks popularly known as “Omashonisa”. As the name suggests (killers or sinkers), predatory lending can wipe all future income of households and lead to unhealthy finances. As these microfinancing options are illegal in South Africa, there is no available data to show exposures and cost to households. They are, however, extremely expensive with monthly interests possibly as high as 20% to 30% repaid with the capital.
The cost of debt depends on the type of debt. There are two main types of debts:
- secured credit (borrowing against an asset for home and car loans)
- unsecured credit (credit cards, personal loans and overdrafts)
Secured credit is generally less expensive and closely related to the prime rate. Unsecured credit attracts high interest rates but is easier to obtain. Avoid unsecured credit, which is often used for consumption and not for buying durable goods.
Why you should know your credit rating
Your credit score is a number, usually from 0 to 999, which represents your use of credit and your financial conduct. Companies that extend credit, use your credit score to see how likely you are to repay loans and if you are at risk of not repaying. The higher the score the healthier your financial conduct and credit use and the more likely you are to get better interest rates because you are less risky financially. Preferential interest rates are a form of saving and allow funds to be allocated to household saving and reduction of debt.
South African consumers are entitled to a free credit report from each of the four credit bureaus every year, quickly and easily obtained online. You can review your credit score, stay informed of your credit status and verify the accuracy of the information on record. If anything is incorrect, it can be fixed so that it doesn’t affect you in the future when you need to apply for new credit. In spite of this information being available, only 1% of all South African credit-active consumers check their credit reports regularly according to TransUnion.
Maintain a healthy credit rating
You can maintain a good credit score by paying instalments on time, closing unused credit accounts and ensuring that credit limits are not used to the maximum. You should also note or query any inaccuracies picked up on your credit report with the institution involved.
Other healthy practices include:
1. Reduce or pay off debt, especially debt with higher interest rates, such as overdrafts, personal loans and credit cards.
2. Reduce the amount of credit used to a lower percentage of the limit granted.
3. Reduce the frequency of credit applications. Consider your requirements and be honest with yourself whether you qualify for the credit you are applying for.
4. If you have a problem paying your existing debt, it is prudent to speak to the service providers and make alternative arrangement rather than ignoring calls. Judgments or administration orders issued by courts have a negative impact on your credit record and score and can affect you for years to come.
While debt or credit is not the only determinant of how much households save, it is a critical component that households can control. Use it to set yourself up for a better future and healthy financial well-being.
With the advent of Covid-19, lower interest rates to save economies mean the cost of servicing debt is lower, which should benefit debt repayments if used properly.
South Africa’s low savings rate stifles growth
Various research reports show that South Africa’s household savings have been declining over the years. It is one of the lowest in developing economies.
SARB and Stats SA statistics also show that even though disposable incomes have been increasing, the ratio of household savings to disposal income has been negative. Households are saving less because they have to pay for day-to-day expenses. This has a huge impact on retirement and reliance on government for welfare.
Household savings are vital in planning for retirement, saving for a rainy day, accumulating assets, saving for investment and settling debt as proven by various economic studies.
To be in control of your finances and live within your means, you should start off by budgeting and staying true and honest to the budget. Engage the services of a qualified financial planner. Have an honest discussion around your personal finances with a view of setting up a financial plan that will help you improve your financial well-being.
Joseph Phiri is a certified financial planner at Alexander Forbes