The difference between good debt and bad debt
South Africa’s wide inequality gap, high unemployment rates and poor economic growth have pushed more South Africans below the poverty line. According to a report released by StatsSA, South Africans became a lot poorer between 2011 and 2015, a trend that is expected to continue.
Many South Africans struggle to make ends meet and turn to credit to finance their day-to-day needs, leading to the misuse of credit. This is evidenced by the household debt-to-disposable income ratio of 72.6% in the second quarter of 2017 - a significant jump from 54.1% in 2000.
According to Vera Nagtegaal, executive head of Hippo.co.za, while credit can be an empowering tool, financial literacy plays a big role in understanding how it makes one’s life easier. “The impact that a lack of financial literacy contributes to the shocking debt numbers can’t be ignored.”
“Credit isn’t necessarily bad – but how one uses it could determine how well or poorly it will serve you,” Nagtegaal says.
She explains that consumers should empower themselves with the knowledge that can help them to differentiate between good debt and bad debt.
Good debt is the type of debt that will pay off in the long run. It can be a home loan or student loan. You anticipate that the gains you’ll make in the future will make up for the cost of the house or qualification.
There are different forms of bad debt. The most basic form is money borrowed that can’t be repaid. Bad debt is also regarded as debt that’s used to purchase things that bring little or no long-term value. It’s also usually high in interest, like credit card rates. Items bought using bad debt will usually be consumed or lose value long before the debt is paid back. For instance, buying food that you’ll eat this month but paying for it over six months would be considered a bad way to use credit.
Managing the debt
Nagtegaal says that some people can find themselves so deep in the debt trap that keeping up with monthly obligations becomes overwhelming. “The first thing you should consider doing is to speak to your creditors and make a suitable payment arrangement.”
For some, this may not be a viable option and turning to consolidation loans may ease the pressure. This could provide respite in the short term but can end up being more expensive in the long-term.
“The other danger with consolidating debt is that you might be tempted to open new accounts, or start using again paid up accounts – which would begin yet another cycle of indebtedness,” cautions Nagtegaal.
Those who can’t seem to take control of their finances can opt for support from debt counsellors, also known as debt reviewers.
Nagtegaal explains that the debt review process is a formal legal process and you’ll need to have your financial circumstance assessed by a debt counsellor. “The National Credit Regulator has a list of registered debt counsellors and we also offer access to a debt counselling service on our website. Should you qualify, your debt counsellor will put together a suitable debt repayment plan, including all the necessary fees applicable to the process.”
The impact of debt on insurance
What many people who go under debt review are not aware of is that this process could also affect their insurance premiums, Nagtegaal points out. “Your insurance premium is calculated based on your risk profile as well as your adherence to financial commitments. A change in your financial situation alters your risk profile.”
Some insurance companies do not pay out if you fail to notify them that you’re undergoing debt counselling, which makes it essential for consumers to alert them as soon as they start this process.
Nagtegaal says this change may affect your premiums, but it’s best to be open and upfront with your insurers. “In most cases, insurers can look at alternative cover options to lower the premiums, such as removing certain benefits or customizing the cover applicable to their current needs, in order for individuals to manage their financial risks.”
“It is essential that people understand that they shouldn’t be afraid of their finances. When their debt becomes overwhelming, consumers should consider getting help from experts to regain control of their money,” says Nagtegaal.