The lockdown has reminded us of financial advice that we are all aware of but may have neglected things were mostly fine because our salaries were getting us by. We now remember what we have been told about keeping money for a rainy day income is suddenly not guaranteed because of the lockdown.
word by khotso ramphele
Some of us have received letters of retrenchment. Some of the Managing Directors we work for have emailed us letters stating that due to income not coming in, they will not be able to pay us. The self-employed are also under pressure as their debtors aren’t paying due to uncertainty of how long the lockdown will last. Along with uncertainty around income, banks have been offerings overdrafts that are higher than the salary you take home. However, a loan of R150,000 will have a high interest rate of over 20%.
In addition, as a response to the lockdown, some banks have offered payment holidays, which might give you a similar feeling to when you buy a new car and the bank says to you “hey, the first three months is on us.” So, you make plans with that extra money. The question is, what happen after the lockdown when we are stuck with debt and money has not been used appropriately?
Let’s be honest, the is no such thing as a payment holiday. They are accumulating interest and extending your payment period. Well, Albert Einstein did say that compound interest is the eighth wonder of the world. So the financial institutions will be reaping the benefits of the compound interest from these payment holidays. Paying debt off has always been a difficult thing with sacrifices to be made. We look at two theories on paying off debt in relation to the lockdown debt we’ve been offered: The Avalanche Theory which focuses on listing our debt from the highest to lowest interest, and the Snowball Theory which focuses on listing your debt from the lowest balance to the highest.
1. Payment Holiday: Some of us were struggling financially before the lockdown period and have taken the payment holiday as a form of relief. If you can pay the extra interest as a result of being at home and not spending on entertainment, then after the lockdown you should go ahead and settle that clothing account with that extra money you have.
How do you approach it?
List your debts according to the Snowball approach developed by businessman Dave Ramsey, where you list your debts from the lowest to the highest.
Clothing Account – Balance: R3,200 Payment: R500
Capitals Loan – Balance: R8,000 Payment: R2,400
Car Loan – Balance: R180,000 Payment: R4,200
Home Loan – Balance: R750,000 Payment: R7,200
It might be a payment holiday, but interest will still be charged. Ensure that all the other charges are paid to a minimum; those being admin charges as well as credit life and interest if you have taken it.
If you have taken a payment holiday on car and home loans; after paying the interest and all other charges, ensure that you settle the clothing account with the money that you have saved, and whatever is remaining you will throw it into the capitals loan, therefore, reducing the term. The next month you will use the R500 from the clothing account towards paying off the capitals loan account faster.
2. Banks offers:
Paying off debt is about sacrificing the things you enjoy and taking care of the essentials. The lockdown has shown us that we can live without going out, spending on alcohol and other compulsive buys.
The best approach is to look at our budget and take care of the fundamentals; food, utilities, shelter and transportation. When those four have been listed and you have put in a fair value of the budget. The remaining amount should be used to settle your debts.
Let’s look at an individual who takes home R18,000 a month, with no dependents.
• Shelter: Rent or a bond should not be higher than 25% of the net income which is R4,500
• Transportation: All transportation costs including car payments, insurance and petrol should not be higher than 25% of the net income R4,500
• Food: Your Food and toiletries should not be higher than 15% of your net income R2,700
• Utilities: Electricity, water and other utilities should not be higher than 10% of the net income R1,800
So you took the bank up on its offer and took a R60,000 personal loan, an overdraft of R20,000 and you further increased you credit card to R30,000. You have a total of R120 000 in aggregate debt. Now this cumulative debt has created a post-lockdown burden and repayments are due.
At this point the debt is overwhelming and tend to mess up the budget. Others will end up using the money in the credit card as a revolving loan to help pay the bank loan back and meet our budget.
The best way to tackle this debt is through the snowball approach, where you will list your debts based on balance and payments — ignoring the interest.
Overdraft – Balance: R20,000 Payment: R350
Credit Card – Balance: R30,000 Payment: R2,500
Loan – Balance: R60,000 Payment: R2,700
With the debts listed from the lowest to the highest balance With the debts listed from the lowest to the highest balance — we need to go back and look at our budget and what is remaining after all our monthly expenses are paid, which is R4,500. Please not the calculations are based on net amount of R18,000.
For us to fully apply the snowball effect in settling our debt, we must do what the founder of the theory says Dave Ramsey which is, “live like nobody else”. You will have to go back to your budget and make sacrifices to your food and utilities. Removing 7.5% from the net amount will give you an extra R1,350 towards settling your debt.
Calculation expression: R18,000 x 0,075 = R1,350
Further sacrifices need to be made and the next best place to make a sacrifice is transport. The first will be to review your car insurance premiums, the second is to be disciplined with your driving kilometers — this means no more unnecessary driving to social places, or volunteering our cars for family events. This should reduce another 5%(R225) from transportation, to give us R900 towards the debt.
Calculation expression: R18 000 x 0,05 = R900
So, now we have the R5,500 debt that we need to service and we have an amount of R6,750. We focus on paying the minimum amounts of the debt and the remaining balance we use to pay extra to the overdraft and when the overdraft is settled, we using the remaining moneys to settle the credit card and we then further move to the Loan.
– Khotso Ramphele is the founder of My Advizar (Pty) Ltd and authorised financial service provider in terms of the FAIS Act. He has over 15 years in the auditing, accounting, taxation, business consulting and financial planning. Ramphele is a former financial guru at YFM and can be currently be heard on stations like Power FM and Voice of Wits FM speaking about all things money.
– Please note that the information provided above does not constitute financial advice; in fact, we are precluded from giving specific advice. Generic information has been applied given the context of the subject. We have limited details about you and your circumstances — such detail may impact any advice provided.