Avoid the slippery slope of credit dependency

Good debt versus bad debt

Credit can be extremely valuable in achieving life goals such as paying for tertiary education, buying a car or providing a home for your family. This is called good debt.

However, it can quickly turn into a debt trap if we start to use it for day-to-day living on items we could easily save for. Then good debt becomes bad debt.

As the economy continues to deteriorate in the grips of COVID-19, the average South African has run out of runway, having already depleted savings and now tapping into whatever credit facilities they may have. As a result, many of us are now drowning in bad debt.

While the weak economy is having a major impact on our pockets, we still have choices around financing and managing our money. Now, more than ever, people need to start budgeting, planning and finding ways to earn a bit of extra income.

If we continue to kick our problems down the road with more credit, we will very soon reach a point where we are trapped in a black hole of indebtedness from which it becomes impossible to escape.

How to get out of debt in an uncertain COVID-19 world

Households facing this squeeze have two options: to keep their head in the sand and hope something will happen, or to face the facts and take action.

• Payment relief options during COVID-19

Local banks have all announced payment relief options to customers who cannot afford to meet their instalments; however, you need to specifically request this option – it is not automatic.

Customers in good standing, with up-to-date accounts, and who had been financially impacted by the pandemic would have the opportunity to opt-in for payment relief, aimed at assisting with cash flow needs.

It is important to note that banks are currently only offering this to customers who were in good standing prior to the lockdown, so this is not available to customers who were already missing payments.

If you do select the payment holiday, this will not affect your credit score as it will not be viewed as a default. Before you sign up for a payment holiday, it is essential that you speak to your credit provider to make sure you understand the implications.

• Debt counselling

Another of the options available is debt counselling where you select to go under debt review. While this may carry a stigma or be viewed as a ‛failure’, the truth is, no-one needs to know. You don’t have to tell your friends or even your employer. This is a better than waiting to default and having a judgement taken against you.

Once you are in default the collection and legal fees start to mount and debt that you were already struggling to repay could easily double. Once you enter debt review you are protected from legal action by creditors and a debt counsellor provides a court-issued agreement in terms of a repayment plan.

In debt counselling, all the relevant fees are built into this monthly repayment amount, therefore the consumer pays a single amount per month to an independent Payment Distribution Agency (PDA), which is regulated by the National Credit Regulator.

Once under debt review you may not apply for any credit until all the debts, as per the court order, are settled.

Upon finishing the program, the debt counsellor will issue a clearance certificate confirming that all the accounts listed under the debt counselling agreement are paid up. Home loans are the exception and do not need to be fully paid but must be up to date. The debt counsellor will ensure that the credit bureaus receive the certificate.

Always stick to a regulated credit provider

If you are at your wits’ end or experiencing an unforeseen emergency that requires you to take out a loan, it is very important that do your homework first.

Know that there are regulated lenders and those who are not regulated. Any company that operates within the framework of the law and National Credit Act, like banks, are regulated and are required by law to extend credit responsibly to consumers.

In excess of 40 000 Mashonisas, or loan sharks as they are known, operate illegally in South Africa – they are unregulated, and lend to desperate consumers without compliance with the National Credit Act (NCA).

Only borrow from a regulated credit provider, otherwise you will fall prey to extremely high-interest rates that will make it impossible to pay off the loan in the long run.

Tips to consider when you take out a loan

When you have assured yourself that you are borrowing from a regulated provider, here are some tips to consider when taking out a loan.

1. Calculate your affordability and stick with only what you need

Often when people access credit, they go for what they qualify for and not what they can afford. They end up taking on more debt than they actually need. Make sure you go for only what you need, remember this is money you still need to pay back.

1. Get your free credit report

Your credit report is a history of how you have handled and managed your debt in the past.

Whenever you apply for a loan or any form of credit, the creditor will interrogate your credit report first. This informs them whether to extend you the credit or not and at what interest rate.

1. Know the interest rate on your loan

The interest rate on a loan is effectively the cost of the loan. The higher the interest rate, the more expensive it is to service that loan.

Don’t just focus on your monthly repayments, always familiarize yourself with how much interest you are paying towards your debts.

1. Stick to your payment plan

Once you have been granted a loan and you have some financial relief to fund your emergency, it is time to reflect how you will pay off the loan.

Take a look at your budget and either scale back on your “wants” or find a way to generate extra income so you can direct some of those funds towards paying off your loan.

Your credit score depends on how diligent you are at paying your financial obligations, on time and in full. This means that every month, you should pay at least the minimum you have agreed to pay. If you don’t, this will negatively impact your credit score.

To speed up your loan payment, you can opt to pay extra every month, even if it’s just R100 – this small amount makes a big difference in the long run. Every little bit goes a long way to ensure you get out of debt sooner.

If and when you finally decide you want to get out of debt, you have to come up with a plan of how you are going to do it.

Without a plan, you are just thinking wishfully.

1. Helpful tool: The snowball method

List all your debts, starting from the smallest debt to the largest debt. Focus on the smallest debt first by paying a little extra money every month (remember, even what seems like a small amount goes a long way) while paying the minimum payments towards all the other debts.

Once the smallest debt is paid off, roll that payment towards the next debt on the list. This is called the snowball method.

You can download the snowball method here.

Getting out of debt takes commitment and directing every spare rand towards paying off your debt.

To attain financial freedom and not live from paycheck to paycheck, you must make a resolve that no matter how long it takes; you will become debt-free.