The true cost of debt

In this episode of Change in your Pocket, we expose the hidden costs that you incur when taking on debt.

– Video supplied by BrightRock

Welcome to The Change Exchange, where we are helping you find ways to make the most of out of your paycheque.

The day you start working, banks and retailers will be knocking on your door to offer you credit. On average you will be able to borrow R3 000 for every R1 000 you earn per month. The problem is that you have to pay the money back – with interest. It doesn’t take long before you realise that most of your paycheque each month is going to pay for stuff that you bought a couple of months or even years ago, and very little is going towards your future. Just don’t go there!

What many people don’t realise is that there are a number of hidden costs when taking on debt.

I researched how much one pays when buying an item on hire purchase. Despite legislation that limits the amount a creditor can charge you for a loan, the results were absolutely shocking: basically a R2 800 washing machine paid off over 24 months ended up costing a massive R7 000, more than double the value of the machine.

Based on this quote, you would have paid R300 a month. If you had just delayed the purchase of that machine and saved R300 a month, you could have bought the machine with cash within ten months and saved yourself over R4 000 in unnecessary costs!

Once you had bought the machine, you could continue to put that R300 away into a savings fund and move from being indebted to an appliance store to creating long-term wealth. In a unit trust or exchange traded fund, that R300 per month could grow to R25 000 within five years.

What you are really paying for:

Initiation fees are charged upfront to cover the administration costs of the loan. The maximum initiation fee that can be charged is R1 140 including VAT.

Admin/service fees are charged for the administrative costs involved with servicing the loan every month.

Credit life insurance covers you for risks like death, disability and retrenchment. Although technically you are allowed to shop around for this cover, many lenders will not lend the money unless you take cover with them – and the rates can be very steep.

When buying a household item, you will be asked to have product insurance against loss or damage of the item you’re buying. If you already have household insurance, you should not be required to take out this cover, but some stores won’t approve the sale if you refuse this cover.

When it comes to interest rates, unsecured credit is usually charged at higher interest rates than secured credit which is given on an asset such as a house or car. Although interest rates are capped to certain maximum levels according to the National Credit Act, they can still be as high as 5% a month or 60% a year.

Short-term debt should be avoided at all costs – and this includes clothing accounts. If you can’t afford to pay cash for those shoes, clothes or handbags, then you can’t afford them. And remember: if you cannot pay off your credit card in full at the end of every month, you cannot afford your lifestyle.

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