Smart Investing – Good debt, Bad debt

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Pay the bond off first?

Everyone’s ‘relationship’ with money and debt is different, and it also evolves over time. At the beginning of our working lives we are likely to have been influenced by our parent’s money values, either behave in tune with it, or diametrically opposite. Few of us have the means when younger to be able to afford a house or car without financial assistance, so this is often the first debt we take on. Whether we get store cards or credit cards, and whether or not we pay them off in full at the end of the month, or rollover the minimum is probably one of the first financial behavioural cross-roads we come across. I have never been a fan of the ‘slippery slope’ philosophy, but there is no doubt that it exists – it just that most of think we are too smart to fall into that trap. Starting to accumulate debt for everyday expenses – rather than for major assets – is often the start of that slippery slope that far too often leads to a slew of maxed out credit cards with very little investing taking place.

Bonds are usually the biggest debt, and the one people are most concerned about paying off first. I often come across clients that want to use provident/pension on changing jobs to pay off bonds, so let’s look at it objectively:

The interest rate on your bond is probably around 9.5%. This debt is ‘cheap’. You might have been able to get a low interest rate from your car finance (they need to move their stock, not have it on the show-room floor so when demand is low, they ‘subsidise’ the interest rate.) Do you know the interest rates on your credit cards ? (Most of them now have it both on your online profile and on the statement). It is likely to be between 18-28%! Short-term loans are probably also in this range. So-called ‘payday’ loan’s effective interest rates are horrific – 600-1000% per annum plus all sorts of admin and late fees. Should you be ‘investing’ in your credit card or in something that is actually going to be an asset

As soon as the interest rate you’re paying on your debt goes over 10 – 12%, your investment is unlikely to do better, so paying off that debt makes the most sense. Store cards that have no-interest for 6 months might seem like a cheap alternative that will ‘save’ you interest, but it is unnecessary debt for day-to-day non-essential expenses. Theoretically, if you shop at a store that has ‘free’ credit you should be able to get a 5% discount for cash – ask for it. You won’t get any discount for paying with a credit or debit card – the retailer pays a fee for that transaction.
There is a very simple step-by-step strategy when it comes to taking back control of your debt, and diverting those funds into your wealth building instead:

    1. Make a list of all your debt, rank them from most expensive (highest interest rate) to lowest. Include store cards, even though they are 6 months as cash, they are still debt.
    2. Do you have more than one credit card? Why? For a start you’re going to be paying several hundred rand a year in annual fees for each of them. If you want to have one Visa, one Mastercard (often a good idea, especially if you travel) get a savings account with a debit card. Capitec for example has Mastercard ( and you’ll pay about R4.50pm for the privilage not R50), FNB has Visa. On your list, highlight the cards you are going to close when they’re paid off. Stop using the cards you’re going to close.
    3. Pay off the most expensive (highest interest rates) first then work down the list, paying off and closing (you have to request closure in writing) as you go. If your finances are really tight, even by paying off the minimum every month is going to get them paid off in a year or so – still look for the odd hundred rand here and there that can speed up the process.  One fairly easy way to get a ‘lower’ interest rate is to ask the financial institution for the ‘equity’ that is in your bond – in other words that portion of the bond (the capital) that you have already paid off. If they will advance this to you, at the low mortgage rate, use it to pay off your credit card debit. Obviously if you don’t have the discipline to follow this sort of debt reduction strategy, don’t dip into your bond and get even more into debt.
    4. Once the credit card you have decided to keep is down to zero, instruct the financial institution to debit the full amount on the due date (not when they feel like it – it usually 55 days from first debit). Your only debt should now be your bond and car, with interest rates below 12%. If you have a business loan, the interest on that will be deductible from tax, making the ‘real’ interest rate that it would have to beat higher than the 10-12% in your personal name. Unlike other countries in the West, interest on our mortgage is not tax deductible. If you work from home, part of the interest on your bond may be tax deductible, but please speak to your accountant so you know the long term CGT implications before making this move.
    5. Do you have an emergency fund with at least 3 months after tax family income? If not this should be top of your list of priorities.
    6. Got your emergency fund? Now take the money you would have been spending on interest on your credit cards and invest it.
    7. Should you use bonuses, windfalls, or cash in retirement funds to pay off bonds? Usually no. This is where emotion comes into the equation. For many people having debt, any debt is deeply uncomfortable. For a start, retirement funds should never be cashed in for any reason. It should be preserved in an investment that preserves the tax status until retirement. The tax you’re going to pay on cashing in the investment is horrifically punitive – starting at 18%, and going up to 36%. It will take years of great returns just to get back to the same place. Bonuses and windfalls are far better being invested in properly structured long-term investments – a TESA for example (see HERE for more details on Tax Free Savings and Investments).
    8. How do you get ‘comfortable’ with Bond debt? Until you learn to live with your bond, you’re going to be tempted to pay it off, and even make poor choices to do so. Try this: Find out what rent you’d be paying to stay in a house like yours, in the same area. Unless you have a 100% bond and have ‘lost equity” (the price has gone down since you bought) then it probably isn’t much different. If you didn’t own your home, you would have to rent (and pay off someone else’s bond!). Look at your bond as ‘rent’ and rather build up your wealth. Unlike ‘renters’ though, you should be living ‘rent free’ in 20 years (unless of course you’re eating up all your capital by hopping properties every couple of years – see HERE for more on this.

Action: Have a clear wealth plan. Get your Financial advisor or coach to put a timetable in place to pay off debt (if necessary) and work out exactly how much money you are going to need to invest to retire comfortably and meet your other financial objectives. Importantly, make sure the risk of not being able to earn an income in the short and medium term are addressed. Give Dawn a shout if you need help HERE

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Author Dawn Ridler  

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