Know the difference between good and bad debt


JOHANNESBURG – Few of us earn enough money to buy life’s important assets, such as a home, car or university education, with cash savings. Even if you could live debt-free, it might not be wise to dig into your life’s savings and leave yourself without any financial backstop in an emergency, or cash to invest for your retirement.

“Most of us are raised to believe that all debt is bad, but this is not necessarily true. It all comes down to whether or not the debt is good debt or bad debt, and there is a distinct difference between the two,” said Nkazi Sokhulu, the chief executive and co-founder of Yalu.

“Good debt is used to generate long-term value that provides you with an asset at the end of your loan term and increases your net worth – in other words, it has some investment value. Think of a bond used to purchase a home. With low interest rates, and as long as you bought wisely, your property should grow in value, so that at the end of the loan you have a tangible asset with a value that outpaced what you originally paid for it, including the interest.

“A student loan is another example. A tertiary education is likely to secure you a higher future income as a skilled individual.

“If you’re in a position to obtain part-time work while studying, make a point of paying off as much as you can afford on your student loan each month. That way, by the time you start your career, your loan could already be paid off, or at a minimal balance, which is a huge head-start in life,” said Nkazi.

A car is an asset that most people cannot afford to buy without finance.

“Although a car is a depreciating asset and the interest rates on the loan are typically higher, it’s essential for most people to get to work and transport their families around. The best thing you can do is to pay in extra every month over and above your instalment, to reduce your outstanding balance as quickly as possible and save on high interesting bearing monthly payments,” said Nkazi.

Bad debt has high interest rates and is usually incurred to fulfil a want, rather than a real need, and does not leave you in a better financial position.

Good or bad, too much debt of any kind can trap you in a financial crisis. If you are considering taking on any type of debt, do a thorough financial assessment and make sure you can afford the repayments and the costs that come with the loan. Pay attention to the term of the loan, and any special conditions, the interest rate and the cost of credit life insurance, which most loan providers make mandatory as a condition of the loan.

“Make sure that as much of your instalment is going towards paying off your loan amount rather than funding overpriced credit life insurance.

“Credit life insurance will pay the total remaining balance of the loan in the event of death or permanent disability, or it will pay monthly loan instalments in the event of temporary disability or retrenchment. The number of months covered varies from provider to provider, but the legal requirement is 12 months. You are not obliged to take out this cover with the loan provider,” said Nkazi. 

PERSONAL FINANCE 



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