January is the month when commitment to New Year’s resolutions is at its highest. ‘Paying off debt’, which is likely to feature heavily in most peoples lists, alongside ‘quit smoking’, and ‘lose weight’, may still prove difficult however, especially after all the festive season spending.
Paying off debt is no easy task, otherwise everybody would be debt free and South African’s wouldn’t be the world’s biggest borrowers, according to the World Bank. In an effort to aid the fight against indebtedness, Moneyweb has put together five key steps to take when embarking on the seemingly impossible journey of paying off all your short-term debt in 2016.
Tackle the most expensive debt first
Executive director of Galileo Capital Warren Ingram says the first port of call is to review all the debt under your name, to figure out what is costing you the most in terms of interest. He says many people make the mistake of paying the smallest amount of debt first so they can achieve a psychological milestone of paying debt off, but this goal is misguided.
Says Ingram: “If you have a personal loan of R2 000, which costs you an interest rate of 9%, and R20 000 owing on your credit card at 25% interest, then the strategy should clearly be to pay off the credit as fast as possible and only pay the minimum on your personal loans until the credit card is paid off.”
Carry out an income statement analysis
Andrew Duvenage, director at NFB Financial Services Group, says it is important to understand your income versus your expenditure on an ongoing basis. He says people have a tendency to only look at their budget at one point in time, but argues that this prevents them from having a fundamental understanding of what they are spending money on and what element of that is necessity and how much of it is luxury.
“It’s an assessment that’s difficult for all of us. [But] we have to look at all the debt that one has accumulated and ask; how much of it was absolutely necessary,” he says.
“There are certain things in my mind that should not be financed. If you went back 30 years, cars weren’t bought from finance. Today very few cars are bought for cash. But when you start financing clothes and consumable like groceries, then it becomes a very slippery slope.”
Withdraw all your investments and savings
Financial planner at Liberty Life Munaf Mukadam says it may be worthwhile to withdraw all your savings and investments in order to pay your debts, especially if the interest you are paying outweighs the returns you’re getting. The more liquidity on the investments, the better. What you don’t want to do is withdraw from your retirement fund or any investment where you would incur penalties for doing so. Bear in mind that once you do pay those debts using your savings, you have to stay debt-free.
Says Ingram: “90% of the time, it’s a great idea. That is, when someone is guaranteed to remain debt-free thereafter. But if you have a spending problem, then it is really not a good idea, because you would effectively be losing in savings to fund an unsustainable lifestyle.”
Trade your car in for an older model
This option only helps if it means your monthly car payments will be reduced. Ingram says that if your car is too expensive for real income to sustain, it could be causing your short-term indebtedness…especially if you’re having to borrow in order to survive the month.
“Obviously there are costs because you’re going to lose value on the car you’re selling, but then you just have to make sure you don’t compound mistake when buying another car. Buy a car that’s at least two years old, that has lost a significant portion of its initial value, and for which services are affordable.”
If selling your car won’t at least cover the amount owing to the bank then this might not be the best option to consider.
Lastly, you could restore your debt, or consolidate it at a lower rate. Duvenage says this can be a good option for home owners who can use money from an access bond to pay off expensive, high-interest debt. However, this option requires a very high level of discipline because it only works well if you continue to make repayments and if the debt remained expensive.
“If you have credit card debt and the monthly repayment is R5 000 a month, you can consolidate that into longer-term debt at a lower rate. And if you maintain that payment level, it will cost you a lot less to pay,” says Duvenage.
“The risk with taking that route is that if you are not disciplined and you use an access facility to pay off credit card debt, then all that debit remains in your bond over a longer term [and you end up paying far more than you would have before consolidating].”
To sum up, avoid living beyond your means. There is no point paying off all your debt unless you plan to remain debt free, and that means getting rid of old habits. And it all comes down drawing up a budget. Ingram says that all people who have spending problems invariably fail to draw up a budget.
“You have to look at how much money you have left after you have paid all your expenses and saved and live only on that amount for the remainder of the month. It’s the most boring answer in the world but there is a reason why it works.”