Have you ever wondered how much your debt is actually costing you? By the time you’ve included all the interest and fees payable, it’s probably a lot more than you realise. You will find that in most cases you can easily save enough to take care of those “money moments” by planning ahead and therefore not having to pay all those hefty interest payments and fees that come along with debt.
Most short-term debt is simply a lack of planning. So, this year, instead of taking on more debt, plan for those money moments by starting a contingency fund in a high-interest savings or money-market account.
The payday/emergency loan
If you borrow for less than six months the microlender can charge up to 5% interest a month, which works out at an obscene annual rate of 60%! They can also include an initiation fee, monthly service fee and credit insurance.
So, if you borrowed R10 000 for four months, you would pay back:
- R1 430 in interest
- R1 150 initiation fee
- R276 in monthly service fees (R69 per month)
- R180 in credit life premiums (R45 per month)
Your monthly installments including all fees would be R3 258, paying a total of R13 032 over four months. That loan cost you over 30% of the amount you borrowed!
Action: If you support extended family, rather than being an ATM, discuss what expenses they will be incurring that year and how much you are prepared to commit towards those expenses. And then save towards it in your contingency fund.
How to save: If you had rather saved the installment of R3 258 each month, then you would have R10 000 saved within three months. So, just by planning ahead for your needs and saving instead of borrowing you would save yourself over R3 000.
The holiday/lifestyle loan
If you took out a one-year loan, your interest rate would be lower as longer-term unsecured loans are capped at 27.75% per annum. But even if you qualified for a lower rate – say, 16% ‒ the impact of the fees will still result in a significant cost.
If you borrowed R10 000 over 12 months you would pay R1 190 a month, paying back a total of R14 280, or 42% of what you borrowed. The longer you borrow for, the more it costs. On a two-year loan, that R10 000 at 16% per annum would cost you a total of R16 176 – or 61% more than you borrowed. That is over R6 000 spent on interest and fees.
Action: If you are planning a holiday this year, or have another planned discretionary expense, create a proper budget to work out how much it will cost you. Then calculate how much you need to be putting away into your contingency fund each month in order to reach that goal.
How to save: If you saved R1 190 a month in a money market account earning 5%, you would have R10 000 in just over eight months, saving you R4 280 in unnecessary fees.
The car loan
The longer you finance your car, the more you will pay. For example, if you purchased a car for R200 000 and financed it over 48 months, your repayment would be around R5 270 per month. By the end of the period you would have paid R253 000.
If you financed it over 54 months, your monthly repayment would be lower at R4 450 per month, but your total repayment would actually increase to R266 935 as you are paying interest for longer.
If you financed the car over 72 months, your repayment is only R3 910 per month, but your total repayment is R281 525. It is worth keeping in mind that by the time you have finished repaying your car, it would only be worth around R75 000 due to depreciation – so the real cost has been your total repayment less current value, or R206 525.
Action: If you want to buy a car, calculate how much you will be spending on repayments, petrol, insurance and maintenance and make sure you can afford it. Remember the type and value of car you buy will affect all of those costs.
How to save: Never use short-term microloans to pay the deposit – you can save that amount in just a few months. For example, if you save the value of your future monthly car repayments you should have a 20% deposit saved in four months and then finance the car over no longer than 48 months.
The home loan
Although home loans have a lower interest rate than other types of loans, due to the length of the period you end up paying the same amount of interest to the bank as you spent buying the property!
Action: Apart from a 10% deposit, you will need to cover other costs of buying a home like municipal deposits, legal fees and moving costs. Do your research, budget and plan so you don’t start homeownership with short-term loans.
How to save: The best way to lower your total cost is to save for a deposit. Putting down a 10% deposit on a R1 million home (R100 000) will save you almost R1 000 per month – nearly R240 000 over 20 years. If you save your future mortgage repayments in a contingency fund, you could build up a 15% war chest to cover your deposit and transaction costs within 15 months.
This article first appeared in City Press.