You don't have any debt? How do you expect to buy a car or a house one day?
That's the response many adults will give you when you tell them as a young graduate that you are avoiding acquiring credit.
In SA, over-indebtedness is almost normalised. Many South Africans take on debt over the holiday season as they overspend on presents, parties, clothing, and travel. The desire to create memorable experiences for loved ones can encourage people to overlook budgetary constraints. Having accrued various forms of credit card and store card debt, without fully grasping the implications of high interest rates and strict repayment terms, many people find themselves starting the new year in a precarious financial position.
“Understanding and managing debt is crucial for long-term financial wellbeing, as it can significantly impact your ability to save, invest, and achieve financial goals,” says Shafeeka Anthony, marketing manager of personal finance website JustMoney.co.za.
“January is traditionally when people take stock of their financial situation and decide on fresh beginnings, so this is an ideal time to learn more about debt and take control of your money matters.”
Shafeeka says that a critical aspect of managing debt, and unlocking the key to financial peace of mind, is understanding the difference between good and bad debt.
- Good debt: An investment in the future
Good debt means borrowing money to invest in assets that have the potential to increase in value over time, or to generate an income, says Shafeeka. Some examples of good debt include:
• Student loans: Investing in education can increase your earning potential and long-term career opportunities.
• Mortgages: Buying a home can be a wise investment as you’re paying off your own property, which generally appreciates over time.
• Home improvement loans: Using a personal loan, or home equity loan (home loan refinancing), to renovate your property can increase its value markedly.
• Business loans: Borrowing to start or expand a business can increase personal wealth and profitability.
• Vehicle loans: Financing a reliable, value-for-money car can be a strategic move if transport is necessary for your work and increases your ability to generate an income.
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- Bad debt: A burden on financial health
Bad debt is incurred for purchases that do not contribute to wealth-building, or do not provide long-term value, says Shafeeka. Examples of bad debt that can quickly lead to financial strain include:
• Credit card debt: Accumulating credit card debt for non-essential purchases, and not paying it off in full at month-end.
• Lifestyle loans: Taking out loans for items with no lasting value, such as tech gadgets, fashionable clothing, and extravagant holidays.
• Financing a rapidly depreciating vehicle: Financing a car that depreciates rapidly in value, and requires expensive repairs and parts, may be a poor financial decision. Debt and credit scores
Understanding your credit score is a crucial factor in managing debt. This is a tool that lenders use to decide whether you’re a low-risk or high-risk borrower. Lending institutions such as banks check your score and accompanying report in detail before providing any kind of loan or credit. Your credit score also determines the interest rate you are charged.
Managing and repaying good debt has a positive impact on your credit score. On the other hand, accumulating bad debt, and failing to make timely payments, impacts your score negatively. Poor financial behaviour makes it challenging to access favourable financing options in the future.
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“Given the tough economic climate, few of us can pay for a car or home in cash,” says Shafeeka.
“Using credit is unavoidable; being able to obtain a loan or bond can make all the difference to your lifestyle. If you can obtain a loan at a favourable interest rate, this adds up to a saving of thousands of rands over the payback period.
