In this first instalment of a two-part series Michael Bouchier looks at how you can avoid making the 11 most common credit mistakes…

(Click here for part two of this series)

1. Spending money you don’t have

   It’s quite a simple concept really, but we all do it — spend money we don’t have. How do we do it? We create debt. Any time you spend more money than you have, you have gone into debt.

   Let’s say for instance you successfully apply for a credit card and you’re quite happy with this new prestige symbol. The bank has granted you a limit of R5000 and you spend R2000 in the first month. When you receive your first statement from the bank they will indicate that they expect you to pay R100 this month towards the outstanding balance. You do so. Guess what? You’ve created debt of R1900!

   The simple formula: if spend is > income then you’ve created debt!

2. Pre-spending money you expect to receive in the future

   You’ve submitted your tax return and met the deadline. Your tax consultant tells you that SARS owes you R8000 and you’re quite pleased about this. It was difficult to get by every month because so much of your salary was going to the taxman. It feels good to have someone else owe you money instead of owing all these creditors money — the banks for your car and home loan, the credit card companies for your credit card, the school for your kids' school fees, etc. Owe, owe, owe — where does it ever stop?

   The next weekend you go shopping in your local mall and you happen to walk past a travel agency that is advertising an all inclusive, seven-night stay in Mauritius for R6500 per person. You briefly start to dream about how wonderful this would be, before it occurs to you that you can't currently afford this luxury. You’ve got school fees due soon, you need to catch up the arrears on your rates and taxes as well as lights and water. Also, you overspent on your credit card last month so you need to throw some more money in there, right? No, you can’t afford it — its just too expensive.

   Suddenly you remember the tax refund and your heart skips a beat, then two. Maybe you can afford it. After all the refund will definitely happen, won't it? The flight leaves in a month and the taxman has been slow at refunding lately — you know, because you waited for eight months last year. But what the hell, the money will come. You walk straight into the travel agency, book the trip and rationalize that you will refund yourself when the taxman refunds you.

   What’s wrong with this scenario? Three things.

   Firstly, the refund from the taxman is not guaranteed. He could disagree with your tax consultant and you could actually end up owing him money!

   Secondly, you will need to finance the cost of the trip pending the refund. This will probably involve going into debt, meaning you'll have to factor interest into the cost of the trip.

   Thirdly, is the prospect of a refund not an opportunity to save and invest the money? Get the money working for you — save it, invest it and watch it grow. That’s the real clever way to do it!

3. Consolidating debt into a consolidation loan

   This can be a wise thing to do, but a lot of people get it all wrong. It’s wise if you have some expensive debts 'hanging around' that you want to tidy up and consolidate into a larger debt and then use the full payments that you were spending on the smaller debts to 'throw into' the repayment of the large consolidated debt. It’s not wise if you simply want to reduce your monthly commitments by extending the term of the repayment of the smaller debts.

   Let’s look at an example. You have the following debts and commitments:

   Debt	Outstanding balance	Interest rate	Monthly instalment
   Bond	R350 000	11 percent	R3612
   Car loan	R200 000	13 percent	R4550
   Credit card	R15 000	22 percent	R750
   Overdraft	R20 000	17 percent	R1000
   Total			R9912

   You’ve owned your home for eight years now and although you bought it for R370 000 it’s now worth over R1-million. So your monthly debt commitments are R9912 and since you earn R15 000 a month after tax, you only have a little over R5000 left to live on including all your debits orders — insurance, armed response, levies, medical aid, etc — as well as groceries, paying the maid, petrol, etc.

   On the advice of a friend you consolidate your car loan, credit card and overdraft debts into your home loan by raising a second bond on your property. So your debt portfolio looks as follows:

   Debt	Outstanding balance	Interest rate	Monthly instalment
   Bond	R585 000	11 percent	R6038

   Voila! You saved R3874 (R9912 minus R6038) immediately.

   What is the problem? There are two issues.

   Firstly, you are now paying off your car, credit card and overdraft over the next 20 years — the term of the home loan versus the much shorter term of the car loan, resulting in an additional debt cost of R386 012 (R621 012 less R235 000).

   Secondly, it is likely that, unless you exercise extreme care and diligence, you will begin to run up your credit card and overdraft balances again. Within a year or two you might once again have large short term debt and you will again need to consolidate your debts, again costing you lots of money.

4. Opening lots of store accounts

   Its human nature! We want it, we can’t afford it and then the store comes up with a plan for you to be able to buy it. We go for it! We get suckered into paying for things we can’t afford and we go into debt to be able to do so. Store accounts are great provided you repay the full outstanding balance every month, or if you open them in order to receive the incentive free vouchers and then close them once you have received the benefits.

   Remember that with a store account you are paying for things you can’t afford with money you don’t have. All these purchases are consumables and you generally don’t have something substantial to show for your purchases.

5. Missing payments

   Whenever you miss a payment on an account, the details of this missed payment are sent to the credit bureaus and a record is kept for the next two to three years of these missed payments. Conversely, when you meet your payment obligations on time a record of this fact is sent to the bureaus.

   When you apply for credit with a credit provider they look at your credit record with the bureaus. If you have missed payments, or paid late, they take this to mean that you are a poor payer, either because you are not diligent in the payment of your accounts or because you are over-stretched financially and are battling to meet your commitments. This is a sign they should not lend you more money.

   Don’t miss payments.

If you have a question or comment for Michael Bouchier, email him here or visit www.credithealth.co.za.

(Click here for part two of this two-part series on how you can avoid making the 11 most common credit mistakes.)

What we waste money on `What do you waste money on?` Most respondents in a new poll seem to agree...

How to budget The disease? Overspending. The cure? Drawing up a budget. Kabous le Roux on how to do it...

Taxing retirement funds The tax considerations of various retirement funds before, upon and after retirement...