Debt is a reality for most consumers, particularly in acquiring the big-ticket items such as a house or car. But how much debt is too much debt? And how much of your salary should go towards servicing this debt?
Eunice Sibiya, head of consumer education at First National Bank, points out that there are several warning signs that indicate you’ve taken on too much debt. These include skipping repayments, borrowing money to pay off debts, and using your credit card to purchase essential items.
Tip: To see how much you're spending on debt, visit this page.
How much should you spend on your debt?
Most commentators agree that keeping repayments to a limit of 30% of your net income is the most prudent way to handle debt.
Pragnesh Desai, CEO of Galileo Asset Managers, notes, “Keeping debt to no more than 30% of net income enables clients to maintain a good grip on their finances. It also provides an opportunity to service the debt responsibly, with a view to ultimately paying it off.”
Graham Knight, former financial consultant at Alexander Forbes Financial Services, agrees.
“The general rule is that no more than 30% of your salary should go towards repaying your big debts, such as a house and car. This, however, can be difficult to achieve. The debt that should be avoided includes credit card and personal loans. The interest charged is usually more than 20% per annum.”
Knight adds, “As a rule of thumb I wouldn’t dedicate more than 50% of my salary to debt. Unfortunately, most consumers are dedicating nearly 90% of their salary to debt repayments. This leaves no room to invest and save money.”
Experian credit bureau notes, as an example, “If you earn R5,000 per month, you should keep your monthly credit repayments to within R1,000 and R1,500.”
Speaking to your credit providers
Experian cautions, “If you are unable to pay your credit provider due to unforeseen circumstances, call or write a letter to explain your situation and make alternative arrangements. Ignoring letters of demand or summons will have a serious impact on your credit profile.”
Desai agrees, stating that creditors will be more understanding if they see you have a plan and are prepared to make sacrifices. In these instances, they will likely try to assist by rearranging or restructuring your debt.
Tips for servicing your debt
Below are some tips to help reduce debt, avoid debt traps, and take control of your finances.
- Draw up a list of your expenses and calculate how much you spend. Compare this to your monthly income. Knight suggests arranging your debt in order from the smallest to largest amount.
- Prioritise your expenses. You need to decide which expenses are essential and which are optional or discretionary.
- Assess each debt, its terms of repayment, the interest you’re paying monthly, and what the debt will cost you over its lifetime, Desai recommends.
- Consolidate your debt where possible. Desai suggests, “Borrow enough from your bank to pay off smaller debts in one go. This way you’ll save money and then have only one creditor, the bank.”
- After paying off credit cards and store cards, close the accounts and destroy the cards so that you don’t use them again.
- According to Desai, if you have high interest- or high value debt you should pay this off first, as the interest you pay on your debt is likely to be higher than any returns you will receive on a sound investment.
- Ensure that you live within your means.
- Generate extra income by taking on a second job or starting a potentially lucrative hobby.
- “Use cash instead of credit,” Desai recommends. Research shows this behaviour will help you save between 12% and 18% whenever you shop.”
- If you are not able to manage your debt, seek professional assistance from a debt counsellor or your bank.
- To ensure that you don’t fall back into your old spending habits, Desai suggests that you budget for small, inexpensive rewards.
- To avoid falling into arrears with your credit providers, Experian notes that it’s important to pay your monthly instalments in full.
Knight suggests that once you’ve drawn up a list of your debt, you can try paying off the smallest amount first. You can then start paying off the second amount on your list. Once you have paid off both amounts, combine the monthly instalments you were paying, to pay off the third-largest debt. This can enable you to expedite settling all of your debt.
Knight cautions that you must avoid getting into further debt while you are making repayments. Once your debt is settled, you are free to move ahead.
“Once all your debts are paid, take the full amount you were paying towards your debt, and save that amount per month going forward,” he recommends.
Desai adds, “Getting out of debt is not an impossible challenge. The solution begins with the correct attitude and a commitment to resolve or improve the situation, undertaken in small steps that will result in dramatic change.”