Getting out of debt

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One of the most challenging thing to do for most people is getting out of debt. In South Africa, debt is very easy to get but very difficult to get out of. Debt can either be good or bad. Using debt to invest in a business or to buy income generating assets can be good provided the profit or income from the investments is higher than the interest payments on the debt.

To most people who are trapped in debt, their financial freedom is greatly destabilized. Debt can even affect the standard of living to a greater extend thereby making many people poorer. Therefore, it makes logical sense why many people will thrill at the thought of getting out of debt fast.

How to get out of debt

1) Do not increase your debt

The most important thing to consider when you are sinking in debt is that, you must avoid the temptation of increasing your debt.

Sometimes emergencies do happen in life and when you have a lot of debt payments to make, your only option may be a new loan. This is why it is very difficult to come out of debt.

This problem can be solved as follows:

• Make sure you are saving money so that in case of emergencies, you can have reserves to sustain you. In other words, you need an Emergency Fund that can help you in a crisis. Therefore I highly recommend everyone to save money before paying off debt.
• Ensure that there is a Gap Cover insurance on your medical aid and car insurance so that in case of emergencies, you will not have to worry about shortfalls. On a medical aid, the Gap Cover will settle the hospital bills in excess of what your medical aid covers.
• Improve your budget by reducing unnecessary expenses.

2) Increase your monthly repayments on loans with higher interest rates

Increasing your monthly repayments on loans results in the following:

• reduction in the total interest payable during the lifetime of a loan.
• the number of repayments are reduced.

Putting extra money on your high interest loans like personal loans and credit cards will ensure that you pay them off fast before they become a burden. Some of these loans can charge interest rates of up to 27.5% which translates to massive interest payments during the lifetime of the loan. These are the kinds of loans you need to get rid of fast to improve your financial stability.

3) Consolidating your debts

For those people with several loans, it can be difficult to manage all of them. Each loan may have a different interest rate and you are also likely to be paying for premiums on multiple loan insurances. Sometimes if you are not careful, you can end up missing payments unintentionally. This will negatively affect your credit score. This can be solved by consolidating all your loans.

Loan consolidation has the following benefits:

• It becomes easy to track the progress of your loan payments.
• This greatly minimizes the chances of missing payments and this will improve your credit score.
• The administration fees and loan insurance premiums are greatly reduced and this will reduce your total monthly repayments.

Please note that if you are not too careful, loan consolidation can be counter productive. Do not be tempted to use the extra money you are saving on monthly repayments for spending. For example suppose your total monthly repayments on all your loans was R 7 000 and after consolidation it was reduced to R 5 000. It is wiser to continue paying at least R 7 000 every month on the consolidated loan so that you can pay your loan faster.

4) Avoid the temptations of payment holidays in case of a crisis

Most people think of a payment holiday as a good option when they are in a crisis. This is not always the best thing to do. Remember a payment holiday is just giving you a chance to skip payments without affecting your credit score.

To understand how payment holidays work, read the following article:

• Payment Holiday – a blessing or a trap?

A payment holiday will result in the following:

• Increased Total Interest payments during the lifetime of a loan.
• The total number of payments will increase.

In case of a financial distress, you need to check if you are covered under a loan insurance. For example if you are retrenched and you cannot afford your monthly debt repayments, you can claim from the loan insurance while you are working on getting a new job.

5) Avoid the trap of revolving loans

The most problematic type of debt is the revolving debt like credit cards. This is because you are allowed to borrow more money before you pay off your initial debt completely.

For more information about credit card debt, read the following article:

• The trap of personal loans and credit cards

Credit cards are very useful when shopping because of their security features and also rewards associated with them but it is often difficult to get rid of credit card debt.

I find it very wise to payback the credit card as soon as you use it. For example if you spend R 1 000 on your credit card on groceries, transfer the same amount back on the same day. If you make it a habit to do this, you will make sure that you are only spending the money you have on your debit card.

Conclusion

Getting out of debt requires great discipline. The most important step you need is to ensure that you do not increase your debt by ensuring that you put money in an Emergency Fund. You can also reduce the number of payments on a loan by increasing your monthly repayments. It is very important to avoid the temptations of payment holidays and revolving loans completely. Consolidating your loans can be very useful if you continue to pay at least the same total repayment amount you were paying before consolidation.

For more information, you can also read the following article:

• Investing before paying off debt – does it make sense?