As people struggle to make ends meet in an environment of rising inflation, households are increasingly being caught up in a debt cycle.
Over the last few weeks, I’ve been speaking to South Africans from various walks of life as part of the shortlisting process for the Money Makeover Challenge.
The picture they’ve painted is not just bleak, it is disturbing. There is a clear trend that is emerging: households have been loading up on credit to make ends meet as salaries have not kept up with inflation. The aggressive interest rate increases, combined with higher costs for food, electricity and transport are pushing households to breaking point.
The rapid increase in credit uptake is a red flag. Unlike a typical credit bonanza driven by confidence in better times, the current credit uptake is being driven by desperate people who are simply kicking the can further down the road and becoming caught in a neverending debt cycle.
According to credit bureau TransUnion, consumer debt levels are on the rise, with South Africans seeking greater access to liquidity to finance the rapidly rising cost of living. The latest figures show that total outstanding balances and new accounts opened are higher across most consumer lending categories.
Benay Sager, head of debt counselling firm DebtBusters, says they are seeing a significant change in the debt profile of those applying for debt review.
The length of time between loan origination and applying for debt review is shortening, which suggests that people are getting into financial difficulties much more quickly. At the same time the average balance of the loan size is increasing. “People are borrowing to put food on the table,” says Sager.
This observation is supported by data from TransUnion which showed that banks were originating higher-value personal loans at increasing volumes, despite the higher interest rates. The data shows that the average new loan value issued by banks has increased by 8% compared to last year.
There has also been a 24.7% increase in new loans issued by non-banks. This increase in non-bank lending is another red flag. Typically, non-bank lenders use lower affordability and risk measures when issuing loans. They tend to be a lender of last resort when banks turn off the taps.
Wihelm Koster, head of retail credit at Capitec says that the bank significantly tightened their lending criteria over the last two years, with only 18% of personal loan applicants and 6% of revolving credit facility applicants taking up an offer. However, Koster says consumers desperate for credit are simply going to microlenders that apply the most basic affordability assessments.
The affordability tests required by the National Credit Act are extremely basic. While credit providers should look at actual expenses by reviewing three months of bank statements, many microlenders simply apply the minimum expense norms which works on a sliding scale according to income.
A person earning R6 200 can have debt repayments of up to R5 000, leaving only R1 200 for living expenses. This would need to include rent, food, transport, education, and other basic needs. A person earning R25 000 a month only needs to be left with R2 855 a month for living expenses.
We have seen payslips from municipal workers where lenders deduct installments directly from the worker’s pay, resulting in a person with an unemployed spouse and three children having only R3 000 left to live on.
The reality is that households who have become dependent on credit to survive will keep looking for more credit, no matter how expensive or detrimental it is to their finances. And there will always be someone prepared to lend to them – at a price.
How the debt cycle keeps spinning
There is a clear pattern emerging of how the debt cycle is kept spinning by further loans.
Households start by taking out revolving credit facilities to help them manage their monthly cashflow as their salaries fall short of their income. They believe this to be a short-term solution until things “improve”. The hope is that they will have a change in fortune such as a bonus or a salary increase.
But like most short-term debt solutions, this only gets them deeper into debt.
They soon find that repaying the credit facility is simply putting them under further strain, so each month they dip further and further into the credit facility until one morning they wake up and discover that they have R100 000 of revolving credit facilities added to their store cards and credit cards. Their monthly repayments on short-term debt alone is making up more than half of their expenses.
They then approach the bank for a consolidation loan which is effectively a personal term loan. This can make sense as the debt repayment is now extended over a longer period, reducing the monthly installment.
Although over time the consumer will pay more in interest, it provides monthly cashflow relief. Unfortunately, most credit providers will offer a loan based on the credit amount the consumer qualifies for rather than what they need.
As a personal loan is seen as lower risk than a revolving facility, lenders offer higher credit balances on personal loans. A consumer who is stretched and trying to figure out how to pay the bills, will grab the opportunity for extra credit without too much thought.
But now the R100 000 revolving credit facility is a R150 000 term loan. This cycle is supported by data from TransUnion which showed that both banks and non-bank lenders are issuing higher-value personal loans at increasing volumes, reflecting consumers’ need for liquidity.
While the monthly installment may be reduced, the term loan has cut off access to monthly credit which the consumer was using to make ends meet. Unwilling or unable to cut expenses, the consumer starts taking on other forms of credit – usually tapping further into their credit cards or taking on microloans. And so the debt cycle worsens.
This article first appeared in City Press.