Struggling with debt can sometimes look like:
- Losing sleep trying to figure out how you’re going to pay for everything.
- Snapping at your family members or colleagues because you’re so frustrated.
- Losing motivation to keep getting up and going to work because what’s the point if the same scenario just keeps unfolding?
- No longer looking forward to pay day.
How much of my salary should be going towards financing debt?
If you want to determine whether you’re in a good financial position or not, you may want to look at your debt-to-income ratio.
A debt-to-income ratio refers to the percentage of your income going towards financing your debt.
What is a good debt-to-income ratio?
A good debt-to-income ratio is 35%-40% or lower. As you head closer to the 50% mark, you should be working on reducing this debt amount. The reason for this is that even if you didn’t take on anymore debt, because of the consistent increase of the repo rate and inflation that we have seen, and may continue to see, your capital debt total may increase.
You will see this, for example, with your home loans and car loans. The amount you are paying today is not the same as the amount you were paying at the beginning of 2022.
How do you calculate your debt-to-income ratio?
Add all your debts/ your gross monthly income x 100.
Example:
If you earn R15 000 per month and your monthly debt adds up to R11 000, this is how you would calculate your debt-to-income ratio:
11 000/15 000 x 100 = 73.33%
If your debt-to-income ratio is over 65%, it's a serious cause for concern and you may want to look at all your options for reducing this debt.
Being approved for credit does not mean you can afford it
Just because you’ve been approved for a set loan amount does not mean you can actually afford it.
While credit lenders do check your affordability, you should do your own due diligence when applying for credit too.
Ever received that text message that you can increase your credit limit on one of your store/retail cards, and you know you are in position to be doing so? This is an example of this. You may be in a position to get more credit, but this could send you into a deeper spiral.
Tips for paying off your debt faster
1. Pay more than the minimum amount
If you want to significantly reduce the time and amount you are paying for your debt, you have to pay more than the minimum required balance each month. By only making the minimum payment, you are charged interest on the capital amount.
This is because what is usually really eating your cash is the interest on your debt amount.
Moku tip: For credit card debt, try not to take your outstanding balances to the next month because you will be paying interest on that outstanding balance and this will mean you will:
- Take longer to pay off the debt
- Pay more than the original price of the debt
2. The Snowball method
After listing your debts, identify the debt with the smallest balance and work on paying off that debt first.
What does this look like in practice?
Pay the minimum balance on all your debts except the one with the lowest balance. For this debt you want to use any extra cash that you have available to pay up this debt. This is when you want to put into practice the “paying more than the minimum balance” strategy.
Once you’ve paid off your smallest debt, identify the next smallest debt. Use the cash that you have been paying on the previous debt + the minimum amount you have already been paying on the new smallest debt. Do this until you have paid up all your debts and are debt-free.
Debt Snowball Example
Debt one: R2500 (minimum balance is R330)
Debt two: R5100 (minimum balance is R650)
If you have R170 in extra cash available each month, using the debt snowball method, you should be paying R500 (R330+R170) every month for debt one until it is paid in full.
Once you have settled debt one, you can now use that R500 you have been paying, in addition to the minimum amount for debt two as your new debt two monthly installment.
This means that, once you have settled debt one, your new debt two payment will look like this:
R500 + R650 = R1150 each month for debt two until you've paid it in full.
From there you'll move on to the next smallest debt.
If you are someone that needs to see progress fairly quickly to keep going, this method might be for you.
3. The Debt Avalanche Method
With the debt avalanche method, you focus on identifying the debt with the highest interest rate and paying that off first.
Once you have identified the debt with the highest interest rate, you need to use all your extra cash to pay more than the minimum balance required on this debt. After settling this debt, you move on to the next debt with the highest interest rate until you have settled all your debts.
The downside of this method is that it requires a lot of discipline and you often have to keep going without seeing significant changes. If you are someone who doesn’t need incentives to keep going, and you can keep focused on your long-term goal, this method could be for you.
The Debt Avalanche Example
Debt one (store card): R2500 at an interest rate of 21% (minimum balance is R330
Debt two (credit card): R5100 at an interest rate of 23% (minimum balance is R650)
Debt three (store card): R1300 at an interest rate of 20% (minimum balance is R110)
Based on this scenario, when you’re using the debt avalanche method, you would want to tackle debt two first because it has the highest interest rate.
This means that you will use the R170 extra cash you have available and add it to the minimum balance of debt two. Your new monthly installment for debt two will be R820. You will pay this until you have paid this debt in full and then move on to debt one.
Moku Tip: Did you know that store cards usually charge a higher interest rate compared to credit cards? Be careful of buying big purchases with your store cards as you could be paying more in the long-run.
4. Debt consolidation loan
A debt consolidation loan is a way to consolidate all your debt and pay one monthly installment by taking out one larger loan.
What’s important to note is that this loan only covers unsecured debt (debt that isn’t backed by an asset like a home or car).
How do you get a debt consolidation loan?
If you are interested in getting a debt consolidation loan, you would need to apply for it from a credit lender. Most banks offer this service. The bank will check your affordability and credit score and then determine whether or not you qualify for the loan.
If you have missed some of your monthly payments or do not have a good credit score, this will affect your chances of securing a debt consolidation loan as you are essentially applying for more credit.
Read more: What is a debt consolidation loan?
5. Debt review (debt counselling)
If you are struggling to make your monthly debt repayments, you have a poor credit score, and you have no extra money to put towards your debts, debt review is the option you need.
Debt review, also known as debt counselling, is a way to help you pay off your debt without taking on more debt.
How does debt review work?
You apply for debt review with a registered Debt Counsellor or debt counselling company and they will first determine whether or not you are over-indebted.
If you are found to be over-indebted, the Debt Counsellor will work out a debt repayment plan based on your debt obligations and daily expenses.
The Debt Counsellor will, during this time, approach your creditors for reduced interest rates for your loans.
You will then, like a debt consolidation loan, pay one reduced monthly installment for all your debt.
Debt review is a legally regulated process by the National Credit Regulator (NCR) and your repayment plan is granted by a Court Order and because of this, your assets like your home and car, are protected. This means that during the time you are under debt review, your assets cannot be repossessed.
Would you benefit from Debt Review?
