A Life of Leverage: Is credit healthy or should I stick with cash?

The days of cash transactions seem to be galloping off into the distance, as the credit craze takes over the world. The traditional concept of ‘living within our means’ has expanded into a blur of squiggly guidelines, as our wallets make room for more cards and fewer banknotes. Should we live frugally, within our means, when there is an abundance of exciting avenues to push us up a level?

South African consumers are given ample opportunity to dive into the wonderful (or scary?) bottomless pit that is debt. We receive daily offers of credit via unsolicited phone calls, promotional smses, shiny advertisements, fat envelopes on the doorstep and mounting email notifications. All sources proclaim debt as the way to making dreams come true. After all, how is the man on the street expected to afford it otherwise?

To Cash or Not to Cash

Let’s consider the cash question. The best financial advice encourages remaining debt-free whenever possible. The simple version is: if you can’t pay cash, you shouldn’t buy it. Circumstances are not always that simple, however.

What if you need something immediately or it is an emergency or it can improve your family’s lives? When should warning bells keep us firmly rooted in a cash-only mindset? Positive reasons to take on debt are easily justified with nonfinancial good intentions. Problems creep in, however, when uncontrolled debt takes over and keeps on rolling.

Use cash first and only turn to credit when it is a wise, sustainable, necessary and temporary liability.

10 Wise Ways To Leverage

So is it advisable to take on debt? And if so, exactly how much are we able to afford? Here are ten key considerations before leveraging your personal financial position:

  1. Interest Rate Woes

    What is the interest rate and the terms and conditions on offer? How does this compare to other similar financial products? Will the rate be adjusted with inflation or an increase in the prime lending rate? Have you actually calculated how much this could potentially amount to?

    Calculate: What is the total amount paid back at the end of my borrowing period; and is worth it?

  2. Institutional Factors

    Which institution, company or loan provider will you choose? A reputable debt provider, like a major bank, is heavily regulated. Accountable for factors like rates and terms of products, regulated institutions tend to be more competitive. Other institutions may ignore legalities, or consumer rights, leaving potential loopholes or taking advantage of naive customers.

    Compare: Repayment rates, terms and conditions, fees and restructuring options from other institutions that offer a similar product.

  3. Liquidity or Value

    Do you need more disposable cash for unforeseen monthly expenses, like a bank overdraft, credit card or short-term loan? Or is your aim to secure something of lasting value, like property, impossible to afford without debt? Depending on the answer, your debt choices will differ.

    Check: The details differ from product to product and loan providers have both standard and unique terms and conditions. Heed the fine print.

  4. Fixed versus Variable Commitments

    Are your credit needs a temporary solution to a deeper problem, or do you need some leeway for a short time only?

    Analyse: Exactly how much will your fixed debt (long-term loans, like mortgages) be affected by adding short-term debt to your financial load?

  5. Budget Amendments

    Take time to calculate how a new debt commitment will affect your current budget plan. Can you afford the repayments easily, or will you compromise other items for the foreseeable future?

    Tips: Include calculations for each month, and each year, until the end of when your loan is repaid. Try different scenarios to see which benefits you the most.

  6. Alternatives to Debt

    Consider looking for alternatives to debt, or changing how you spend. Would it help to control your budget better if you used a smartphone app to record your spending in real time?

    Explore: Use the internet, experts, friends and family to research different ways to save and spend money, before taking on new liabilities. Sometimes a change in perspective is all it takes.

  7. Credit Ratings

    Be aware of how debt affects your credit rating, and how this will affect your future potential borrowing position. Opening too many retail accounts, or defaulting on these repayments, for example, may later affect your ability to get a home loan. The National Credit Act and this blog post have some great pointers on the subject.

    Research: How do you measure up to the recommended debt ratios and how could this affect your overall credit rating in the long-term?

  8. Types of Debt

    Credit cards and short term loans are not the only form of debt available. The perfect form of debt will depend on current financial position, ability to manage future cash flows and credit history.Remember: Be flexible and keep your eyes open for suitable alternatives.

  9. Control over debt position

    Credit cards may look helpful in the short-term, for example, but miss a repayment and the interest will trap you into longer-term commitments and a deepening debt grave. This derails progress and draws precious resources from more important places in your life.

    Remember: Debt should have a clear, achievable repayment plan and leave you in a better financial position than before.

  10. Refinancing options

    There is usually a way to refine your debt position, with the help of experts who know how to work the system. If your debt is taking over your life and you are desperate to find a better way to do things, ask your debt provider or a financial expert for advice. Do not take on new debt to pay old debt.

    Restructuring: Repayments can often be restructured effectively. In extreme situations, debt consolidation may be a last resort.

There are no easy answers for whether to take on debt, how much to borrow, what type of debt to choose or from whom to borrow. Your financial position is unique, as are your needs, dreams, plans and commitments. Don’t ignore the fine print, and seek professional advice to achieve full understanding of the options presented.

Your financial success is your responsibility, a reward from you to you.