As debt eats further and further into our limited resources, we need a strategy to reduce debt.
For example: Gerald owes R5 000 on his credit card and R50 000 on his home loan. The bank charges 24 percent interest a year on his credit card, and 15 percent a year on his home loan. This works out to two percent interest a month (R100 a month) on the credit card versus just over one percent a year on his home loan (R625 a month).
Which debt is the priority to pay off first?
The one with the higher monthly amount may seem to be more important, but this is misleading. The answer is the one charging the higher interest! Gerald would be wise to pay off more than the minimum monthly payment on his credit account to clear his debt as soon as possible.
1. Know your debt
The first line of defence is knowledge. Know each debt, and its terms of repayment. Most importantly, know the interest you are paying each month on each debt. Then you will know which debts are a priority to pay off as soon as possible, and which you can afford to carry a little longer.
2. Consolidate your debt
One way to reduce your monthly debt repayments is to consolidate your debts. You borrow enough from your bank to pay off the many smaller debts at once. You then have only one creditor - the bank.
Do your homework carefully. Check that the overall interest you will be paying is less than the total on your individual accounts! You will have to convince the bank that you can stick to your agreement - in other worlds, that you are serious about your plan.
3. Rationalise your insurance
If you feel you are paying for too much insurance, you can possibly reduce the total amount of your premiums. Get advice.
If you cancel (lapse or surrender) a risk policy, you lose your cover. But if it is an investment policy, you could lose what you have already paid into it. Find out the best way to get your life or endowment policy to fully paid-up status, or whether you can reduce the premiums. Don't lapse or surrender a policy without checking what the implications are. Ask your insurance intermediary for advice, but think carefully if he or she suggests replacing one policy with another.
If you want to confirm that the advice is in your own best interest, you can phone the insurance company's customer helpline.
4. Pay off your home loan
Plan A.
If you pay just 10% more than your monthly instalment, you will pay off your home loan in a much shorter time.
Plan B.
Take any windfall and pay it on your home loan. Use your annual bonus or sell the second family car! An extra once-off payment of R5 000, for instance, will eventually save you thousands more over the term of your bond, because you will not have to pay the compound interest on it!
Plan C.
Unless you have a fixed interest rate, your instalments will change with the current rate of interest. When it drops, keep up the higher payment. You will be surprised how much interest it will save you in the long run!
5. Spend less
The quickest and most sustainable way to get out of debt is to practise self-control. We live in a world which promotes spending. We are subjected to an almost constant bombardment of TV, radio and magazine advertisements urging us to spend, spend, spend.
We need to become more aware of how we are tempted by advertisers to want things that we do not really need. We need to remember other expenses that may become a priority in the near future e.g. school fees, bond repayments, a car. We simply cannot buy everything our hearts desire.
Many people have expensive cars, grand homes and designer clothes. We tend to look at them and want what they have. But remember, real happiness and success come with managing what we have - not trying to have things we cannot afford.