What is the real cost of debt?

Debt

While at university

Today I want to tell you a hypothetical story about the true cost of debt. You went to school for 12 years, only to go to university for another 4 years. Your whole life you have never had your own money. Even at university all of your money came from your parents. You didn’t have any reason to save, you got the bare minimum and you did well reaching the end of the month without that dreaded, “Please mom I need more money”, phone call. You never phoned your dad because you needed that sympathy factor.

Your car was a 10-year-old hatchback that had a lot of kilometers on it from when a family member was still driving it. When the mechanic phoned you to report on everything that needed fixing, your first question was always, “what can possibly last until the next service?”

You start working

Then finally you started earning your first salary. You and your friends have been discussing how you are going to blow your first pay check for months now. It was always something like the latest Sony Play Station and a brand-new car.

You are walking into a decent junior level position and everyone needs to know that you mean business. You are going to work with clients and driving a nice car makes business sense. So, without even earning your first pay check, you took your new employment contract to the bank and they gave you a loan for that brand-new Mercedes-Benz. You didn’t think about it twice, obviously the bank did their math and determined that you will be able to afford the car. Why would you doubt them, it is their job to know how much you can repay?

You have lived in a commune for the last few years and all you want to do is have a place of your own. You start renting a small apartment. The apartment needs to be furnished, and Coricraft is willing to give you a loan. You don’t mind the expense since you won’t need to buy other furniture in the foreseeable future. It makes sense to take the repayment option over the longest possible period since it makes the repayments incredibly small.

You need a new phone and decide that the payment difference between a Samsung A3, you set out to buy and the latest Samsung S9 is only R400. It is all about the extra processing power. Another great option you have is to increase the payments with only R250 per month and get the latest Gear S3 smart watch included in the deal. A year later you are still repaying everything you bought in the first 3 months after you started working. You are still making your debt repayments rather comfortably.

You decide to buy property

A friend of yours bought a property. The option of paying off your own home loan, instead of someone else’s, is appealing. You decide that you also want to buy a property. You are in a serious relationship and you want to have a place that will still be large enough for you and your significant other to build a life together. It should have at least 3 bedrooms, a garden and a double garage.

The bank allows you to get a property with a repayment of a third of your monthly income. You do your math and it looks like you’ll barely be able to afford it. You still buy the property because it is an investment that will only appreciate. While this is true, you must always consider the true cost of debt.

Every month you just break even. Whenever there is a small unexpected expense like tire replacements, you don’t mind using the credit card because you need to drive. Every month when you receive your salary a little bit of it is used to clear the credit card debt. You don’t monitor this too closely because you can always pay off the debt when you get your salary. The amount you need to repay systematically increases until you need to use your entire salary to clear your debt.

The debt tower collapses

At this point you are literally on a knife’s edge and living off your credit card. Except for food and things you really need, all your money is going towards debt. If anything goes wrong, you are going to miss debt repayments. Even worse is that you could get laid off. It might not even be your fault, the company you work for went broke. You might be in a car accident and when you bought the car you did not read the fine print on the insurance. Your excess is 10% of the car’s purchase value. This is when the tower collapses.

The moral of the story is that debt has a way of taking over your entire salary. Banks try to determine whether you can afford the debt they are granting you. However, the amount you can repay depends on too many factors that they do not have control over.

When you purchase something on debt, you always need to ask yourself whether this is the minimum I need to satisfy my needs. Would a second-hand Ford Figo or a Huawei phone have done the trick? Could you have rented a few more years and bought a place for you and your family once the a three-bedroom place was justified? Be wary of debt and try to buy cash. If you can’t, then you need to ask yourself if you can really afford what you are buying. The cost of debt is simply too high.

Be safe out there,

Hendrik

Quote of the week

“If there is anyone to whom I owe money, I’m prepared to forget it if they are.” – Errol Flynn

End note

Thank you for reading to the end. Apparently, the average person spends 8 seconds on a page, so you are special. If you have any suggestions, feel free to drop me a mail on the contact page. If I missed anything or you have questions, don’t hesitate to comment below. I might even notice it and respond. Lastly, if you want to be bombarded with mails known as the newsletter I send out once a month (if I remember), please subscribe on the right. All information is based on my opinion and you can read more about this in the legal disclaimer.

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