What is Debt?

As children, we’re taught about finance in very simple terms. You work hard, you make money, and you use that money to pay for the things you want. But when you grow up you learn a very different lesson – There’s just not enough money! No matter how prestigious your job is, few people have enough cash on hand to just go out and buy a car or a house. Others don’t even have enough to cover the basics like food and water. When we run into these situations, we’re normally presented with an easy option – Just get a loan. Borrow the money and pay it back later when you can afford it. This is a tempting offer and, at times, it can’t be turned down. But what happens afterwards when the due date comes and it’s time to pay your debt? How much is too much? What is Debt?

Debt is just something owed by one party to another (although it’s almost always money). Debt is a fairly common occurrence in the world of finance as few groups are able to make all their purchases with the funds available to them and it becomes necessary to borrow money from others.

This money is commonly loaned with interest which means that the party doing the borrowing will normally have to pay back more than they were given.

As mentioned, many of us don’t have the ability to stay debt-free throughout our lives. There’s going to be times when you’re forced to go into debt and that can be scarier than it sounds. So, if this is largely unavoidable, let’s familiarise ourselves with it and ensure we don’t make too many mistakes.

What does In Debt Mean?

Being ‘In Debt’ means that you have borrowed money from a certain group which you now owe back. Debt (especially larger amounts of it) is seldomly paid back all at once, and thus, getting out of debt usually takes a long time.

All this raises the question, how much is too much? Well, before we answer that we first have to figure out how debt levels are calculated.

What is a Debt-to-Income Ratio?

Your Debt-to-Income Ratio (commonly abbreviated to DTI) is simply the percentage of your gross income that goes into paying your debts each month (Note: Your gross income is the amount of money you earn before subtracting your taxes and expenses).

If, for example, you make R10 000 before taxes each month and R5 000 goes into monthly debt payments, you would then have a DTI of 50%.

DTI is used by lenders to work out your borrowing risk, in other words, it’s going to be very difficult to get something like a mortgage if your DTI ratio is too high.

How Much is OK?

While it’s generally better to have no debt at all, most experts would agree that, if you have to go into debt, it’s always a good plan to ensure that your DTI is as low as possible as higher ratios can make it harder to successfully pay off your debts. Additionally, a higher borrowing risk can make it much more difficult for you to receive beneficial loans.

It should be noted, however, that South Africans are currently facing much higher DTI ratios than normal and most of us will be hard-pressed to keep our ratios down in the current financial climate.

How do I Get Out of Debt?

Getting out of debt can be tricky and oftentimes plans need to be personalised to the individual in question. Luckily, there are some general principles that can help us form a basic framework to get out of debt –

• Create a Budget – One of the easiest mistakes to make involves creating a rough plan of debt payment in your head and then only half agreeing to it. If you don’t know how much trouble you’re in or how much money you have to spare, how will you possibly get out of it? Your first step then, involves figuring out how much you owe and how you can pay it. If you can’t find the required cash, you may need to determine which parts of your lifestyle can be altered to save extra money each month.
• Pay more than you Need to – Whenever you take out a loan, there’s normally a minimum amount required for payment each month. If you find yourself with enough extra funds at the end of the month, why not put that towards your payable amount and get rid of the debt sooner? Remember, if there’s any interest involved at all, the longer you take to pay your debt, the more expensive it will end up being.
• Prioritise – Again, interest is your enemy when it comes to debt. The higher the interest rate, the higher the total cost that’s required of you. In order to curb this, consider prioritising the payment of high-interest loans to get them out of the way early.
• Break the cycle – Getting rid of all your old debts isn’t going to amount to much if you immediately replace them with new ones. Once you commit to getting out of debt, try to ensure that you don’t take out any new loans that are going to add to your current issues.
• Debt Relief – In extreme situations, certain institutions may deem you eligible for debt relief. This may come in the form of lowering interest rates or even wiping away the debt entirely in bankruptcy. There are, however, downsides to debt relief so make sure you know all the facts before you give it a try.

How Can I Stay Debt Free?

As mentioned, debt is truly unavoidable for most of us. Unless you’ve got a particularly high-paying job, most dreams of owning a property are going to come with certain levels of debt that just have to be accepted. But this doesn’t mean it’s impossible and there are some tips that can help you live debt-free (or at least get as close to it as possible).

• Make a Budget – Once again, you need to have a firm grasp on your finances. People who make purchases and hope that they’ll have enough money to cover everything will find themselves in debt very quickly.
• Live within your Means – Luxury items are very tempting, especially in the moments right after you’ve received your salary and money seems plentiful but keep in mind that they all have costs attached and frugal living can really help you stay out of debt.
• Ensure that you have Savings Available – If you make it to the next month with money to spare and no more debts to pay, why not save it? As nice as it would be to reward yourself with a shopping spree or a night out on the town, it’s normally wiser to keep a little nest egg tucked away in case you need it.
• Be on the Lookout for Better Interest Rates – Don’t just accept the first offer that comes your way. If an interest rate seems too high, do the math and think about shopping around until you find a better deal.
• Don’t let your Loans Get Out of Control – Try to pay your bills as soon as possible. Procrastination + interest rates = Debt.

In Conclusion

Debt is a common factor in most people’s finances. It occurs whenever you owe money to another party and usually comes along with some level of interest over time. Because certain purchases (such as property) are normally too expensive to handle alone, many people end up incurring some level of debt that cannot be reasonably avoided. With that in mind, debt can also get out of control and taking on too much or letting it go unpaid, can cripple you financially if you’re not careful.

It’s helpful to work out your Debt-to-Income Ratio (DTI) when dealing with this problem. This is simply the percentage of your gross income which goes into debt payment each month and, so long as this percentage isn’t too high, individuals are usually able to pay it off over time. That said, a high DTI can make payments very difficult and can negatively affect your borrowing risk which will make lenders less likely to do business with you.

Whether you’re trying to get out of debt or avoid it entirely, certain basic guidelines can be extremely helpful, these include –

• Create a budget plan.
• Live within your means.
• Pay off loans as soon as possible.
• Prioritise individual loans.
• Avoid high-interest rates.
• Maintain some savings in case you need them.

In extreme scenarios, financial relief can be sought out but this option has its own downsides which need to be considered.

Disclaimer Finance101: All of our posts are for research purposes only. Finance 101 aims to assist its readers with useful information on the laws of our country that can guide you to make financial decisions that will enable you to become more financially independent in the future. Although our posts cite the constitution in many instances, they are intended to assist readers who are looking to expand their knowledge of the law & finance related queries. Should you require specific legal/financial advice we advise you to get in touch with a qualified financial expert.

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