A South African perspective - Calculations might differ with other currencies but the end result is the same - Income might be lower or higher but you live according to your income and the banks are just helping to compound the problem.............
A lot has been written and spoken about the subject and various ideas and words have been added to it. The fact is that Debt and the application thereof has been the undoing of people since time immemorial .
Debt is like any addiction: It is very hard to let it go or to get rid of. There are all sorts of methods employed to rid you of the illness. But like everything else people get addicted and nothing helps.
The exception proofs the rule: The few that do eventually get out of it shows that the majority never will. There is only one way to get rid of debt – permanently – and that is to never get into it.
It should be a compulsory subject in schools – “How to survive without debt” or “living life free of debt”. A name for it is irrelevant – the outcome is all that matters.
Let us have a look at debt: In today’s world it means to borrow money from a bank or other willing money lender. It is to be repaid over a specific period in the future and you will be charged a fee on it called “Interest” This can be a specific amount or a percentage calculated on the original or outstanding amount – normally regulated by some law. If you are late with payments or skip a payment additional interest is added and as a rule this accumulates. (Or is compounded) That and the method applied initially to calculate the interest is why it is called compound interest.
Now enters the banks – They have to lend out money to survive – there is no other way. They will lend you money based upon a set of rules which not even they understand – the following example is based on these rules.
It is absolutely essential that the reader understand the basics of this and I am going to explain it with a simple example.
Family of 3 – one child going to pre-school
So .......you earn a salary of R20 000 and clear after tax R 18000
The bank has decided to give you a home loan of R 600 000 over 20 years at an interest rate of 10.5% per annum. Your repayment is R 6000 per month of which R 5250 is interest
They also finance a car for you costing R150 000 over a period of 60 months at an interest rate of 14.5%. Your repayments are R 3526
Interest portion is R 1812.50
Total interest portion of these two purchases is R7062.00 (Month one)
This is just over 39% of your Nett monthly income after tax.
( Oh yes actually 41.5% if tax is calculated correctly)
So between the taxman and the bank you have spent 50% of your income on interest and tax. And you still have to live.
Cash flow of course is another story – debt consists of capital and interest.
Your monthly debt repayment on these 2 debts alone amounts to R9526 per month which leaves you with on R8474 per month to live on.
What else do you have to pay for ? That is the big question – and I am going to be very lenient in my calculations:
1. Medical aid R2000
2. Telephone R200
3. Fuel R 1200 (About 1200 kilometers per month or 40 per day)
4. Clothing R 300
5. Food R3474
6. Gym R 200
7. Dstv R800
8. Eating out R300
Total of R 8474
The following has not been provided for : Life assurance, Car insurance, Emergency fund , school fees, and a few others. The only place where this can be deducted from is food – and a family of 3 will not be able to survive on R3474 per month.
Corrections to be made : Tax for this bracket is R 2940 per month – oops another
R 940 to be deducted somewhere
Medical aid : Chances are that this will be in the region of R 2500 Plus - oops another R500 to be deducted somewhere.
Pre-school fees R 500 per month – Oops Oops .............
Suddenly this family is left with less than R 1500 per month and no insurance has been paid for and there is no emergency fund and ...wait for it no food yet.
O yes and then there is rates and taxes, water and lights.
The problem is that when the bank considers these loans they accept the figures clients give them and they recklessly approve the loans and will not have one sleepless night about the consequences.................
I dare any bank to differ with me. And yet they will finance these people if they have a clean credit record to more than the amounts I am quoting here .
Here is my final verdict : No matter what banks say they are recklessly endangering the financial future of consumers especially those that do not do their homework on their finances before signing on the dotted line. And the wolf is waiting patiently – sometimes not so patiently.