Question:
I'll pay my last car instalment at the end of May 2009. What should I do with the R2500 extra I have in my budget?

I have credit card debt of R50 000 and an outstanding bond of R265 000. My thinking is to increase my bond to R315 000 to pay off my credit card debt and then just pay extra into my bond each month.

Answer:
Debt — the four letter word that haunts our finances and squeezes our cash flow on a monthly basis. Ironically, having a credit facility can be the most valuable and powerful financial instrument available to us. However, the devil is always in the detail and debt can quickly turn from your trusted ally to feared enemy if treated with disregard and managed irresponsibly.

The rule of thumb always suggests that one should tackle the debt with the highest interest rate first. Generally speaking, the higher the interest rate the shorter the term. It therefore makes sense that one should concentrate financial energy on settling overdraft facilities, credit cards and shorter-term personal loans (normally up to 36 months) before turning to vehicle finance and mortgages.

In our efforts to reduce our debt levels, the Reserve Bank has offered some relief and with it a potential opportunity. Since December last year we have experienced an easing in interest rates of 2.5 percent. On a 20-year bond, this has resulted in a repayment reduction of approximately R182 per R100 000 that you owe (+/- R483 per month for R265 000). With many economists pricing in further cuts of up to 3.5 percent by the end of this year, this could well put one in a position of having a further R238 per R100 000 bond — something that will go a long way in reducing one’s personal debt level and hopefully allowing a position for investment savings.

The above-mentioned approach is essentially deemed as debt consolidation where any and all debt is rolled up into one financial vehicle (usually the bond) to lower the cash flow burden of the higher servicing costs of shorter term debt. Although this strategy has saved many from drowning in their debt, it should be approached with caution. One of the most glaring risks is that should you opt to pay the minimum repayment on the increased bond, you will essentially be paying those 'short-term' debts over the full duration of the bond and ultimately pay more interest (as a rand amount) over the long term. As an example, some fall into the trap of assuming they have settled the finance on their vehicle by consolidating this debt into the bond where in reality they have merely moved the liability. The result is that one would be paying lower instalments over a much longer period. A more prudent approach would be to calculate the repayments needed to cover the liability at the lower interest rate while still maintaining the original term. In this way you will be freeing up some of your cash flow through lower interest rates and avoiding the trap of long-term interest rates slowly putting you back into a net negative position down the line.

With that said, you have mentioned a rand amount you wish to contribute and therefore a rand amount paid towards a lower interest rate vehicle would have the impact of reducing the debt quicker. One other determining factor would come down to whether you have the facility within your bond to enact this. If you do not have this facility available then you need to obtain approval for a higher bond and re-register it with the deeds office, incurring substantial costs. These would need to be closely analysed to ensure you’ll still be in a better position.

In conclusion, one of the most important debt reduction principles is that once you have maximised the consolidation options (if applicable), the role of sound cash management becomes important. It would be of no use if one continued unnecessary spending and landed up with credit card debt once again. For this reason budgeting becomes an important exercise in order to buck this seemingly inevitable trend.

acsis Limited is an authorised financial services provider. The response to the question covers some of the issues in a general and factual manner and does not constitute advice. It is important to consult with a financial planner who, after an analysis of the individuals’ personal needs, goals and circumstances, will be able to provide comprehensive and appropriate advice.

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