The prime rate is down to 14,5%, creating an excellent opportunity to escape debt. Sharon Gill and David Le Page report
Every year you swear you won’t get carried away with the commercialism of the festive season, and every year you go right ahead and blow the budget. Predicted Y2K pandemonium did not materialise, but the party’s over and now the results of the frenzied spending sprees force our attention from the prophets to the profits of doom. What to do, when there’s too much month left at the end of the money?
Fortunately, the Reserve Bank has signalled yet another interest cut. All four major banks, Absa, First National Bank, Nedcor and Stanbic announced prime rate cuts to 14,5% on Friday 14, to take effect from January 19. The adjustment for bond-holders came earliest for Nedcor clients, from January 19, but Absa bond-holders will have to wait until February 7.
We’re now enjoying the lowest interest rates in 12 years, having managed to scramble back from a punishing 25,5% in August 1998. The Reserve Bank says it is unlikely to signal further rate cuts until inflation trends are clearer.
In the meantime, we should have more disposable income, making it an even better time to get rid of unwanted debt.
Instead of having numerous accounts in arrears, or trying to establish a personal “revolving credit” system by transferring funds from one bank account to another and back again, there are better avenues to pursue. Consider these two options:
The first avenue is to discuss your financial situation with your bank manager and anyone else to whom you owe money. Nobody really wants to repossess your car or your house. Businesses have better things to do than claiming possession of defaulters’ assets and having to auction them off to recover monies owing to them. Where possible, they would much rather try to restructure your debt. For instance, they can extend the loan period by reducing the monthly payments or by giving you a couple of months’ grace (so younn could use those months’ repayments to settle your accounts).
But if they’re not aware of your difficulties, they will simply assume that you’re avoiding the issue and trying to evade payment, and follow letters of demand with legal action.
The second avenue, often recommended by bank managers and financial consultants, is to consolidate your debts. You can either apply for an overdraft facility, or exploit your housing bond.
“If you have an Access Bond,” says Erik Larsen, Standard Bank’s media relations manager, “then you can borrow from your bond to settle your other accounts. However, you should not get into long-term debt to settle short-term debts. You need to exercise self- control and pay extra into your bond account until you’ve caught up.”
The reasoning is pure logic: borrow at a lower rate to pay off a debt incurring a higher interest rate. On average, the interest rate on a housing bond is now 14,5%. The interest rate on a debit balance against your credit card is around 24%, and the interest rate on most store accounts is between 24% and 27%. Pay off the credit card account first with money borrowed from your bond, then carry on paying off the bond.
If you regularly have a little spare cash to salt away, consider paying it into your bond account. On a R150E000 bond over 20 years, repayments should be around R2E065 per month. Interest would total more than R345E000, but if you pay just R100 per month extra, you will knock nearly five years off the loan period, which translates into more than R88E000 saved in interest payments.
Remember, paying extra money into a home loan is effectively like investing it at a guaranteed interest rate identical to your home loan nnnrate. Of course, if you’re convinced you’d get a better return on that money by investing it in unit trusts, for example, then you should do so. The home loan interest rate is guaranteed, though, and a unit trust is not.
nnThe rate cut nshould, along with nincreased confidence from noverseas investors, provide an important boost for the economy. In theory, that should mean we’ll all become slightly wealthier. However, the distribution of new wealth can never be guaranteed. Taking steps to escape debt is one way to ensure that you do benefit from the country’s current comparative good fortune.
Bear in mind that in many respects the world economy is becoming an increasingly ruthless place. The only way to ensure your own welfare in the future is likely to be taking command of it yourself. South Africa will never become a welfare state on the scale of the United Kingdom, which although wealthy, is already struggling to maintain social security.
Take this example from Internet-based financial information service Motley Fool, of a fictional couple with very different savings patterns. Fay invests R100 a month in a fund tracking the stock market throughout her 20s and stops in her early 30s when she has children. Husband Ferdinand does not start saving until he is 30, putting R100 from then on into the same (stock market) index tracker fund as diligent Fay. But Fay leaves her money to grow until she is 60, when she has R1,3- million, against Ferdinand’s R489E000.
The figures assume a comparatively modest stock market growth of 14%. The lesson is that compound growth over many years makes a huge difference.
The bottom line is: any extra money which comes your way should be used to settle your debts before you embark on extravagant holidays or flashy sports cars. At all costs protect your credit worthiness; then you’ll still be able to borrow cash for any real disaster.
Once debt-free, with a little bit of discipline you’ll be able to splash out on the good things in life without hocking your soul to the money lenders. And the good things of the future may depend on some discipline now.