In a slow and stagnant economy, South African consumers cannot seem to catch a break. With general living costs rising and expensive debt piling up, households are under immense pressure. Debts often go unpaid, which can have nasty consequences.
How is the pricing of a loan determined?
The cost of debt is determined by the bank and credit providers. Banks and credit providers make their profits by charging consumers interest on the loans they give out. An interest rate is a percentage charged on the outstanding balance of the loan.
As a rule of thumb, the higher the risk of default (not paying), the higher the interest rate charged. High risk loans will therefore be more expensive to the consumer. Luckily for consumers, there are pricing caps as governed by the National Credit Act.
Which types of debt are more expensive?
Generally, asset-backed debt such as vehicle finance and home loans are the cheapest forms of debt. Due to these being secured by a physical asset they are less risky for the banks. This is because if a consumer defaults the bank can repossess or sell the asset and retrieve their loan amount back.
Personal loans and credit cards are more expensive than vehicle or home loans as there is no security for these debts. Therefore, it can be harder for the bank to get its money back from defaulting consumers.
The most expensive type of debt comes in the form of pay day loans. A pay day loan is generally a loan that is for a very short period of time, 1 – 30 days only. These loan can have interest rates as high as 5% per month.
Should you focus on paying one debt over another?
The short answer here is that you should make sure to pay all debts that you have. Missing or short paying a loan or account has consequences. Firstly, it would impact your credit score negatively. It will also mean that there may be extra interest, fees or penalties due to non-payment.
If you are paying all debts on time, then you do have the option of paying more on specific accounts if you can afford to do so. In this case, it may make sense to pay off the higher interest loans that are costing you more.
If you have a lot of debt, you should consider debt counselling.
Debt counselling is a consolidation program for over-indebted South Africans. The process allows consumers to pay a much more affordable debt repayment each month. It also allows a consumer to pay back a lower interest rate in most cases.
This means that a consumer will save money in the short and long term with a focus on becoming debt free. Although one cannot access any new debt while under the process, the new lower installment enables the consumer to afford all necessary living expenses.
The debt counselling process is completed by receiving a clearance certificate, which indicates that all unsecured debt has been settled. This can take between 24-60 months, depending on how much debt you have and how much you are able to afford monthly.
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