The COVID pandemic has placed the already-struggling South African consumer under even more pressure. A salary cut or retrenchment places significant pressure on a household’s budget. This, in turn, leads to consumers defaulting on their debt.
Johann Rossouw, Certified Financial Planner at Fiscal Private Client Services explains that defaulting happens when you fail to make your monthly loan repayments. “Defaulting will drastically reduce your credit score, impact your ability to receive future credit, and can lead to the seizure of personal property. This vicious-circle leads to the question – how does one ever become debt-free?”
Don’t be good at bad debt
To answer this question, it is important to distinguish between “good” and “bad” debt says Rossouw, “Good debt is a loan that you use to build wealth and has the potential to enhance your life over the long-term. Examples of “good” debt include the mortgage on your home or student debt. The benefits of this kind of debt outweighs the costs”.
Conversely, “bad” debt refers to a loan that does not increase your wealth and adds little value to your life over the long term. “Examples of bad debt include credit cards, clothing accounts and payday loans,” he says.
How to become debt free
When starting the process of becoming debt free, it is important to firstly start tackling the bad debts in your life. Make a list of your debts and categorise each item as either a “good” debt or a “bad” debt. In this list, add the outstanding balance and the interest rate you are being charged.
“Once you have done this, the focus should shift towards the bad debt you have with the highest interest rates – these are the loans you should focus on settling first. The easiest way to do this is by paying more than the minimum repayment amount and using any surplus funds that you may have (like bonuses or tax refunds) to settle the debt quicker. This is, unfortunately, not an option for many consumers,” explains Rossouw.
If you are struggling to repay your debts, you most likely do not have any surplus funds available. An alternative option is debt consolidation. Rossouw says that debt consolidation is a way to reduce debt by combining multiple loans into a single balance with a lower overall interest rate and better repayment terms. “Debt consolidation will lead to you having a single, lower monthly repayment which in turn frees up cash flow. The key with debt consolidation, however, is then to use any freed-up cash to settle your debts”.
Envy and greed destroy wealth
“Keeping up with the Khumalo’s is a major factor in spiraling consumer debt. Envy and greed are two emotions that destroy wealth and keep us indebted. It is important that, once we become debt-free, to remain debt-free. Debt should not be used to purchase items we don’t need to impress people who don’t matter,” says Rossouw.
Becoming debt-free is the first (and most difficult) step on the journey of reaching financial freedom. “Once you have achieved this, you can start focusing on building an emergency fund and investing for the long-term – then the fun really starts,” concludes Rossouw.