We all know that having too many personal loans and using your credit card too much is bad. However, debt is often unavoidable. With job losses, salary cuts and increasing general living costs, it becomes quite easy to slip into bad habits. Not all debt is bad but using debt for daily expenses can quickly become a dangerous game.
Why Do We Get Into Debt?
Consumers can get into a lot of debt for many different reasons. Sometimes the dream of a luxurious lifestyle can lead one to over-extend themselves. Sometimes unfortunate events or circumstances require loans or the use of an overdraft. A common trend in South Africa is the use of multiple debt sources and types over a period.
Whether the behaviour of the consumer is out of desperation or carelessness, making sure that the debt can be repaid is particularly important. When urgent debt is needed, the costs and the terms are often overlooked. Some short-term loans can have interest rates of 60% p.a., excluding other fees and charges.
What Is A Pay Day Loan?
A pay day loan is a loan that is taken out for a duration of less than a month. Most providers can break down the cost of this loan per day borrowed. Usually, a consumer can borrow between R500 – R4,000 for 1 to 30 days.
The interest rate on a pay day loan is usually 5% per month or 60% p.a.
So, What Is A Debt Cycle?
A debt-cycle occurs when a consumer runs out of money before their next pay day and must borrow more to make it through the rest of the month. The cycle usually looks something like the below:
a. Consumer gets paid monthly salary
b. All current loan debit orders run off the account (loans repayments, credit card repayments etc.)
c. All service agreement debit orders run off the account (cell-phone contracts, insurances etc.)
d. Fixed costs need to get paid (rent, school fees etc.)
e. Consumer needs to use the rest of the cash for daily living expenses (electricity, groceries, transport etc.)
f. The cash in the account runs out before pay day
g. Consumer is forced to use a credit card, overdraft or take out a pay day loan to make it to point a. again.
This cycle can continue for months. The costs of taking out new loans to fill the gap can be large. Essentially, in the above situation, a consumer’s monthly costs exceed the income, hence the need to borrow more in the 1-2 weeks leading up to pay day.
This is what we call over-indebted. When your income is not enough to cover all debt repayments and living expenses.
How Can You Break The Debt Cycle?
To break the debt cycle you might need some intervention.
Step 1: Work on your monthly budget
If you can drastically cut down on your living expenses you may be able to afford everything in the month. Often, consumers get locked into a particular lifestyle which is unsustainable due to the high debt levels.
By bringing your living expenses down so that your debt repayments and living costs are comfortably less than your income, you have solved this problem for yourself. You will just need to maintain this discipline going forward.
If you have already reduced your budget and cut down on all spending, but still find yourself coming short, read step 2.
Step 2: Speak to an expert
Debt counsellors specialise in helping over-indebted consumers out of debt. In 2007, the National Credit Act introduced debt counselling as a process to rehabilitate over-indebted consumers. A debt counsellor will formally negotiate with all your credit providers to reduce the monthly installments and interest rates on your debt.
The result is a consolidated monthly repayment that is more affordable. You would also get legal protection against any creditors wanting to initiate legal action for non-payment. All types of debt can be included in this consolidation plan, including bonds and vehicles.
A debt counsellors’ role is to assist you and help you to understand your situation. Make sure you approach a company that is registered, follows the suggested debt counselling processes and has a good online presence.