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First, a lesson in finance
The difference between flat interest (which is the rate quoted by your bank) and compound interest. 'Flat interest' is the cost of borrowing money for one year. 'Effective interest' is the total percentage cost of borrowing for more than one year.
For example, if you're considering buying a car and would like to borrow R50 000, you have the power to decide how much, in total, you wish to pay for the car, even if your lender won't budge on the flat interest rate it's offering. And if you structure your loan over five years, you pay R36 303,90 in interest. This is an effective interest cost of 72,61 percent on the total amount borrowed.
However, if you decide to structure the loan over three years by paying R523,24 more each month, you'll pay R20 619,13 interest, which we describe as 41,24 percent effective interest. With effective interest rates on short-term loans running at 72,61 percent and higher, it's little wonder that many South Africans are now buckling under their monthly debt burden.
It's not just about the cost of debt
Having too much debt extends far beyond having to tighten your belt. It also robs you of your ability to save for your retirement. When you ask a 20-year-old when she'd like to retire, a confident '30' is the general response. When you ask a 30-year-old the same question, she may tell you that a yacht on the Caribbean should be achievable by the time she's 40. A 40-year-old takes a little longer to answer and ventures a hesitant '50'. At 50 years old, this question will elicit furrowed brows and mild hysteria. Anyone earning R5 000 or more per month can easily build a comfortable retirement fund, but only four percent of South Africans will ever achieve this.
There are many reasons for the miserable state of our retirement affairs, the first of which is simple denial. Another problem is that many people don't have a clue how much money they'll actually need to retire – and if you don't know how much you'll need, how can you know what to save?
Big income doesn't mean big savings
High-income individuals are notoriously inept at saving because they're convinced that their income stream will go on forever. But to maintain a R30 000-a-month life-style in retirement, they would need to have accumulated over R5 million in investments and have no debt. It's safe to assume that very few of the current 65-year-old high-flyers of this world have even R1 million saved up.
In order to secure a comfortable retirement, you have to save 15 percent of your monthly salary after tax for 30 years. One of the ways to do this is simply to reduce your debt and spice up your savings plans. If you have existing contracts, inquire about paying the balance off sooner and ask how much interest you’ll save by doing this.
So if you want an interest-rate cut, do it yourself by borrowing over shorter periods and paying off some of those revolving credit cards. Believe it or not, you are in control of how much interest you will ultimately pay, not the banks.
Do you think we need an interest rate cut?
