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Five common debt traps and how to avoid them

Jun 27, 2018
Five common debt traps and how to avoid them

Consumer debt has reached over R1.71 trillion, according to the Reserve Bank. In addition, a report by the World Bank has revealed that 25 million South African adults, out of 37 million, owe money to financial institutions or other corporate lenders such as shops that allow them to buy now and pay later.

The combination of the recent VAT increase, the largest petrol price hike ever in South Africa and the escalation in luxury goods excise duty will make repaying debts all the more difficult.

This is according to Peter Tshiguvho, CEO of Metropolitan Retail, who shares his top tips on how to avoid falling into the five most common debt traps, along with ways for navigating back to safety if you are already ensnared:

Credit card debt

Easy bait for the financially uneducated consumer, banks often offer rewards such as holidays, cash back and vouchers to entice clients into the credit world. However, the National Credit Regulator claims that 58% of South African consumers are struggling to pay off their credit cards.  Most credit card users start off with the very best intentions and try to repay their debt, but many end up paying a significant amount of interest simply to keep their heads above water. 

“Before you sign up for a credit card, look at what you can afford and limit your monthly spending to less than that amount. Pay back your debt in full each and every month and your credit card will become a very useful financial tool for building a positive credit rating.  If you have already fallen into this pitfall, lock up your credit card somewhere safe and pay off as much as you can afford until the debt is wiped out,” advises Tshiguvho .

Store accounts

Stores offer massive discounts, special offers and vouchers to get people to sign up for and keep using their accounts. With back-to-school, Easter, seasonal changes, school dances and Christmas, pressure is constantly on consumers to shop more and just put it on account. With this in mind it’s easy to see why 76% of South Africans are in debt due to store cards, according to data from a local debt management firm.

“You need to ask yourself if the store card is necessary,” says Tshiguvho. “If it is, make sure you use it wisely and buy only essentials with it.  Otherwise, cut it up and use cash or other instruments to stay within your budget and avoid the trap.”

Payday loans

Cash-strapped South Africans are increasingly turning to payday loans as a quick solution for making ends meet if they run out of money before the end of the month, but unfortunately this noose starts tightening rapidly once the first deadline is missed. Interest mounts up and many consumers are forced to borrow to repay the interest, leaving the original debt unpaid and attracting even more interest. 

“This avenue should be carefully explored before applying.  If you have already gone down this road, pay the debt back as quickly as possible,” says Tshiguvho.

New car loans

The shiny chrome and new leather smell of a new car appeals to many motorists to the extent that they forget about their budgets and commit themselves to rampant debt. Relatively recently, loan periods were extended so that consumers could repay a new car loan in up to 72 months. 

To ease the monthly burden on motorists even further, balloon payments were introduced. This allows for lower monthly payments, but the final monthly payment could be as much as a third of the total loan.  This puts ownership out of reach for most people. 

Tshiguvho suggests that you let your brain dominate your heart in this decision, which has long-term and extensive financial implications on take-home pay. 

“Analyse your needs and meet them.  Second hand vehicles offer good value for money with good warranties. With reasonable kilometres on the clock and good record keeping, a five- to seven-year old vehicle will provide great durability.”

Hire Purchase

Previously prevalent in the furniture and appliance industry, Hire Purchase (HP) is now a popular means for financing car purchases. The downside is that the interest rates on these contracts tend to be higher than the prime overdraft rate of interest.

What’s more, as you are hiring the item until you have paid the full amount, failing to pay could result not only in the item being repossessed, but you losing all the money you have paid so far.

Tshiguvho recommends deferring your purchase until you have saved the money to pay in full for the item. 

“If that isn’t possible, get a professional to review the draft HP agreement before you sign. You must also make sure that you can afford the repayments.”

“Before making potentially debt-inducing decisions, consumers should take some time to consider the long-term consequences. In addition, they should speak to a financial advisor who can help them make sound choices that will pay off in the long run,” concludes Tshiguvho.

For more information visit www.metropolitan.co.za.