There are many reasons that people get into debt, usually they can be categorised into one of the following three:
- Ignorance,
- Indulgence, or
- Poor Planning
Debt is often the symptom of some “other” issues but that is the subject for another post. In this post I want to look at the first category: ignorance. This is where someone has no idea of the real cost of the debt. For example, few people stop to think that the total cost of all the interest payments on a million rand house over 20 years is over R2.3million rand – R1.3million of that is interest!*
The National Credit Act has made it a lot easier for people to know the full cost of a financed purchase as the total cost of the item being purchased has to be displayed. This includes the interest, finance charges and even insurance charges. So if you are buying a car and financing it, you must be shown the full costs of financing it over the period for which you have opted and even advertisments are supposed to show this information (take a closer look next time you see one).
But one of the areas that has fallen through the cracks is the cost of having debt while trying to save at the same time. Consider the following fairly typical example:
- Client A has a current account which is in overdraft of R7000. At the same time he has R11000 in a bank savings account just to see himself through any financial emergencies.
While the principle of an emergency fund is an excellent one, what he has not realised is the cost of keeping money in it while he is in overdraft.
Typically banks now charge a monthly fee for the “privilege” of having an overdraft facility on your account. One bank that I contacted today charges R57 per month for this (that’s R684 per year!). At the same time they levy an interest rate of 16% per annum on overdrawn accounts. On R7000 that amounts to R1120 per year – so the total cost of the overdraft is R1804 per annum.
Now at the same time, the positive interest that they pay on R11000 in a savings account is 0.25%, or R27.50 per year (this is criminal). So the real cost of this financial compartmentalization is R1776 per year! Of course the bank know that the client is wasting money and if you ask them, the would probably advise against doing this kind of thing but then again, if you dont ask, they make more money and that’s what they are there for.
So my advice is to use the money in the savings account to pay off the overdraft and then use the money you were paying into the overdraft to build up the savings account again. And better still, use a money market unit trust account instead of a bank savings product – you will get about 6.5% interest per annum (Capitec bank offer 7% on balances under R10000).
* interest rate of 10% per annum.
