Beware the rising cost of debt
While higher inflation pushes up the cost of living, South African consumers also face rising interest rates. Higher interest rates are welcome for savers and pensioners living off an interest-based income, but they’re bad news for the millions of South Africans who are paying off debts.
The monetary policy committee of the South African Reserve Bank is set to meet this week, and all signs point to another repo rate hike, with some even predicting a jump of 75 basis points (0.75%). You need to be prepared for this and further hikes during the year to avoid falling behind on debt repayments, and you certainly want to avoid taking on unsecured debt over this period.
As can be seen from the graph, the prime interest rate, which is 3.5% above the repo rate and which reflects the most favourable rates offered by banks to their customers, dropped dramatically after the highs of the 1990s, stabilising around 10% in the decade from 2010 to 2020.
Then Covid hit, and in an effort to boost the economy, the Reserve Bank slashed the rate to record low levels, with the prime rate falling to 7%. Consumers who feel the debt pinch the most will be those who took on debt at that time.
It’s possible that the prime rate will reach the pre-pandemic level of 10% by the end of the year, resulting in a substantial difference in repayments on a large, long-term debt like a home loan.
Adrian Goslett, regional director and chief executive of Re/Max of Southern Africa, says existing homeowners and buyers alike should check what their repayments will be at various interest rate levels. They can do so by using the repayment calculator on BetterBond’s website.
For example, on a R1 million home loan taken over 20 years at the current prime rate of 8.25%, the repayments would grow by over R1 000 if the rate reached 10% (see table). If you took out a R1 million mortgage in July 2020 when the rate was 7%, you would pay about R1 900 more than initially.
“Equipped with this knowledge, existing homeowners can work out where to cut back to afford the higher repayments. For buyers, preparing a table like this can ensure that they purchase a home that they can truly afford, even if interest rates climb further,” Goslett says.
The rate hikes will also hit rentals, so Goslett advises tenants to leave room in their budgets for rental escalations over the coming months.
Tips for the over-indebted
Tej Desai, chief executive of Alefbet Collections & Recoveries, a group of collections firms, says over-indebted consumers, especially those with a high proportion of unsecured credit, are likely to come under pressure as their debt servicing costs shoot up alongside living costs. “The absolute clarion call right now is for indebted consumers to take a proactive and disciplined approach to paying down their higher-interest debt, and to proactively engage with their credit providers if they find themselves in difficulty and unable to afford their monthly debt repayments,” Desai says.
“There is a readiness by South Africa’s credit providers to restructure debt given the unprecedented circumstances consumers find themselves in. Indebted consumers should use this opportunity to reach out proactively and negotiate before they default and find themselves caught up in a costly and stressful legal collection process.”
Desai offer some tips if you’re struggling with debt and are facing higher repayments:
1. Engage proactively with your creditors if you are at any risk of defaulting on your debt repayments – don’t ignore your creditors and debt obligations.
2. Prioritise your expensive debt. If you can, increase the amount you pay back each month and start with your debt that has the highest interest rate. As you pay off one debt, divert the money you were used to paying to top up your next repayment, which means you’ll be significantly reducing your term and interest charged.”
3. Be careful of using your home loan to consolidate your debt. “While this may be a good strategy, depending on your circumstances, what you absolutely do not want to do is put your home at risk by consolidating your debt and then falling behind on your repayments. Also remember that, while the interest rate may be lower on a home loan, the repayment term is much longer.”
4. Think carefully about debt review. “While this is an option for a heavily indebted consumer, it is not a process that should be entered into lightly. Once you’re in debt review, you cannot obtain new credit and you cannot exit the process until you have settled all your debts (with the exception of your home loan).”
5. Cut discretionary spending and avoid the bad debt trap. “If you are in a financial bind, it’s important to cut the consumption debt traps that only get you into further bad debt – such as groceries and impulse buys on your credit card, entertainment and eating out, gym and pay-TV subscriptions, and clothing accounts.”
6. Protect your credit score. “The better your credit score, the less expensive your debt repayments will be, as you’ll qualify for more favourable terms and interest rates. Your credit score is a vital financial measure that can either be an enabler or a hindrance, depending on how well you manage your debt. It’s one reason why it is so important to engage with a credit provider or collections agency if you find yourself unable to honour your repayments, and to rather put a new payment plan in place.”
PERSONAL FINANCE