Debt Management Tips

Profit from Curbing Your Borrowings

March 28 - 29, 2009. Debt management is a vital part of your effective financial planning

On a personal front, few of us enjoy debt. Though some take the opportunity to gear themselves to take advantage when a particular business opportunity arises, for the average investordebt is just a necessary evil and careful debt management is required.

South Africans are known to be heavily indebted, with the aggregated South African debt-to-disposable-income ratio increasing to over 77% in 2008, up from just under 50% in 2002.

While a lack of debt management can be crippling from a financial health point of view, there are certain occasions that require nearly all individuals to borrow money. Very few of us can afford to buy houses and cars for cash and as such mortgage bonds and vehicle finance are generally unavoidable. While this debt is seen as quite acceptable, we should be careful to not adjust our lifestyles too quickly to increases in disposable income. Typically, increases in disposable income come about through increased salaries or a reduction in the prime lending rate.

In the current economic environment of falling interest rates and depressed house prices, many of us may be tempted to buy houses that were unaffordable a year ago. However, even though interest rates appear to be coming down over the short term, with its high interest rates (by international standards), South Africa has expensive debt. Assuming we qualify for a mortgage bond at a rate of prime less 1.5%, by repaying the bond we are effectively receiving an after tax risk free return of 11.5%. For debt management purposes, it is usually a good idea to focus on repayment of the debt as quickly as possible.

A good financial planner can discuss with you the implications of focusing too heavily on paying off debt. Some of the implications of focusing too heavily on this would be missing out on tax advantages associated with retirement savings as well as the possibility of missing out on the effect of compound interest on your investments.

Here are a few useful debt management tips for repaying bonds quickly

• By paying slightly more than the minimum on your bond each month, you will repay the total debt significantly faster. For example, on a R2million bond, increasing your repayment by 10% will result in you paying off the bond in 14 years instead of 20 years, and saving over a million rand in interest. The accompanying graphic shows this saving in interest, as well as the reduction in length of paying off the bond.
• When interest rates do come down, ask the bank to keep the repayments at the current level. This will allow you to continue the same level of monthly spending but will also result in you paying off the bond much faster. If you did this in 2000, you would not have felt the effects of the increased bond payments recently.
• If you are paid on the 25th of each month, arrange that the bond repayment is made on the 26th of each month instead of the last day of the month. I am amazed how much one saves in interest over the 20 year bond term.
• Keep excess cash in your access bond facility: Have your salary paid into the bond account or keep your savings in your bond account instead of in a separate savings account. If you are a provisional tax payer, you may want to keep your tax money in the bond account until its time to pay it over. The effect of keeping this excess cash in the bond account is that you are able to reduce the monthly interest charge and as a result more of the monthly repayment is allocated to repayment of capital. Furthermore, the saving on your interest expense will be far more than the interest you would earn on a positive savings balance – and remember that interest earned is taxable. However, take care to investigate the possibility of drawing these savings out of the bond before entering into this type of arrangement as some banks have introduced conditions when withdrawing funds from access bond accounts.

Another word of caution when thinking about mortgage bonds is to remember that interest rates will fluctuate over the period of your bond. We should not make the mistake of buying property when interest rates are low, forgetting to take account of the fact that interest rates can, and likely will, increase. This can put significant pressure on property owners as we have seen over the past 2 years. If you are buying at the limit of your budget, it may be a good idea to discuss fixing the interest rate with your bank. Your financial planner will be able to discuss the merits of doing so.

Also consider very carefully before making any changes to your existing facility. The interest rates being charged at present are higher than you would have received a few years ago. Thus a small increase to your facility could cost you an extra 1.5% on the whole loan. You may wish to consider a second mortgage or an alternative type of loan if this is the case.

In order to maximise your debt management correctly, it may be appropriate to engage an independent, fee-based Certified Financial Planner who can provide impartial written advice. If you are unable to secure a referral then visit the website of the Financial Planning Institute on www.fpi.co.za. Meet with a few and select one who is qualified and can demonstrate what process they follow to help you review your own financial plan.

Debt Management
An Extra 10% Makes A BIG Difference

Ian Beere, CA(SA) CFP was Financial Planner of the Year in 2007. His business partner Debbie Netto-Jonker CFP, founder of Netto Financial Services, was Financial Planner of the Year in 2001.