The real cost of holding debt
08 March 2016
Posted by: Author: Michel Pireu
Author: Michel Pireu (BDlive)
Spending habits of consumers have changed significantly over the last century," says Octogen director Paul Slot. "In the 1900s, food and housing took up 60% of household income and virtually nothing was spent on transportation. Fast-forward to 2016, and a different picture emerges; in a modern economy lifestyle aspirations influence consumer spending far more than in the 1900s."
Octogen, which specialises in financial wellbeing, have monitored the spending patterns of South African consumers in the past 15 years, "during which time the capacity to spend has improved, but the spending mix has changed", says Slot, who breaks consumer spending down into three categories: household expenditure; risk expenditure — including insurance, medical aid, pension saving and own saving for retirement — and rent and debt repayments.
Based on the model developed by Octogen, financial security tends to be achieved by those consumers who spend in the region of 35% of their after-tax income on household items, 25% on risk expenses and 35% on monthly debt repayments, leaving a 5% cushion for emergencies. However, today the average consumer spends roughly 34% of their after-tax income on household items, 17% on risk protection and 49% on monthly debt repayments, leaving no margin for safety.
Spending within these numbers has also changed. Whereas the average spend on household items has reduced slightly in the past 15 years, more is now spent on food, transport, rates and taxes, electricity and education, while spending on communication, security and luxuries have decreased. Spending on entertainment has remained constant at 6% of after-tax income.
What is alarming is the reduction in average consumer spend on risk services, from 23% to 17%. Both the number of consumers and the percentage spend on short-term insurance have decreased, with the number of consumers who spend nothing on short-term insurance now sitting at 34%. Spending on funeral insurance has increased significantly. Spending on medical aid has increased to an average of 9% of after-tax income — despite a 2% rise in the number of consumers with no medical aid. And while saving for retirement has remained fairly constant over the years, the number of consumers with no savings has increased to 32%. Nearly one in three!
"This trend was also visible in the number of consumers who are members of a provident fund, who called us to discuss the feasibility of using provident fund savings to reduce debt before the implementation of the Taxation Laws Amendment Act," says Slot. "The culture of live now and save later goes a long way to explain why less than 6% of consumers can currently maintain their lifestyle after retirement."
On the plus side, SA has the sixth-largest percentage of pension fund assets to gross domestic product in the world.
What is probably less surprising is that the average spend on monthly debt repayments has showed the biggest increase across all categories in the past 15 years. Average monthly debt repayments have risen from 36% to 49% of after-tax income. The biggest increase in debt repayment comes from personal loans, and loans to acquire furniture and clothing. The average spend on this last category has risen from 7% of after-tax income 15 years ago to 27% today. That is more than the average spent on either housing or motor vehicles.
The average South African now spends about 23% of their after-tax income on housing, either rent or bond repayments. Average monthly repayment on vehicle purchases, excluding running costs, amounts to about 17% of after-tax income.
According to the World Bank, South Africans are the biggest borrowers in the world, with 86% of the population in debt. The National Credit Regulator says 10.3-million South Africans are finding it difficult to meet their monthly debt repayments.
Consumers’ financial health is an important factor in the wellbeing of any economy, and to achieve this in SA, the household debt-to-income ratio of 78.4 has to be reduced. One of the main obstacles to doing this lies in the fact that consumers with money trouble seldom realise the seriousness of their situation until they reach a crisis point.
Another hurdle is a general ignorance on the holding cost of debt, a problem that begins on the day that debt is first acquired when instead of asking about the cost of credit, consumers nearly always focus on the affordability of the monthly repayments. Slot says this is best illustrated in the decision to purchase a house, when many consumers select a 30-year bond, which reduces the monthly repayment by just less than 10%, ignoring the fact that the total cost of the debt over that 30-year period will be 40% higher.
Consumers who are over-indebted also tend to underestimate the cost of missing a payment or going into default.
What’s more, consumers who are over-indebted usually ask for a reduction in the monthly repayment, while ignoring the additional holding cost of the debt. The main aim of consumers who find themselves in difficulties is nearly always to improve their cash flow, but later, they will often question the added costs incurred by the extended terms.
The amendments to the National Credit Act (NCR) might reduce future debt-consumption but they will not tackle the current debt conundrum of many South Africans. Instead, the saving grace for many is to be found in the fee and interest rate concessions agreed by credit providers in the NCR Task Team Agreement. In terms of the debt counselling rules system (DCRS), concession-agreement credit providers are willing to forego fees and interest to help consumers repay debt faster. The quantum of the concessions is driven by the repayment commitment of consumers. The effect of the DCRS concessions is a reduction in the holding cost of the debt and ability to repay debt faster.
Therefore, while more than 10-million South Africans now struggle with debt repayments, a large percentage could resolve their money problems by simply engaging sufficiently early to find a solution.
This article first appeared on bdlive.co.za.