If you’re funding an overseas trip with a credit card or buying groceries with a store card that you pay off monthly, then you’re creating debt – spending money that you don’t have. Credit doesn’t come cheap. For instance, if you take out a loan which is not backed by an asset, you could be paying an interest rate as high as 35%.

A scary example

Perhaps you’d like to own a flat-screen high-definition TV; the only problem is that you don’t have the cash right now. A loan of R10,000 may grant you your wish, but you could end up paying more than R45,000 for your TV! Here’s how it works: On day one, the loan value increases from R10,000 to R11,000, thanks to the initiation fee. After one year, the loan value increases to R14,850 as a result of the 35% interest rate currently allowed for unsecured credit. To repay the loan over ten years, you would need to make annual payments of about R4,000 per year, plus a R600 service fee per year. This means that over the ten-year period you will pay a whopping R46,520! What’s very sobering is that after your fifth annual payment (the half-way mark), the balance owing would still be about R9,000.

Good debt versus bad debt

The reality is that most people need some credit to enhance their lives and invest in their future. Not all debt should be labelled as bad. For instance, a study loan could be the best debt you incur if it helps you to gain a qualification that will significantly increase your earnings.  If owning a car will ensure you get to work faster and enable you to work longer hours so that you increase your income, then a car loan may be termed as good debt. Of course, the car you buy should still be affordable in terms of your monthly budget.
 
Most people would not be able to own a house without taking out a mortgage.  A house is an investment in your lifestyle. In fact, a mortgage bond is often regarded as a tax-efficient way to invest in your future.  Again, your mortgage should not leave you gasping for air or make you feel like you’ve been sucked into a black hole. Affordability is key. Using credit to fund overseas holidays, clothes, TVs or other consumer items can be regarded as bad debt. As our example illustrates, having debt comes with huge costs and should not be undertaken lightly.

Are you feeling trapped by debt?

Food prices have risen dramatically over the last year and electricity prices have soared. Many employees have had to cope with higher living costs, while salaries have not always kept pace with inflation. If you have not adjusted your budget, you may have started to rely more and more on store and credit cards to cope with all your financial commitments.  This may seem like a good strategy, but it only delays the pain.  Debt grows with time, leaving you less money to buy essentials or save for your future. If you’re using credit to pay off other debts you could be in the classic debt trap. You need to devise a plan to regain some breathing space.