You want to avoid debt as far as possible. Unfortunately it is not always possible. There are a few important things to consider when applying for debt.

Debt instalments shouldn’t exceed a maximum of 20% of your net salary that you take home after deductions for tax and retirement contributions. Do proper calculations to determine whether you can afford the debt and what impact the instalments will have on your cash flow. Always make provision for interest rate increases when applying for debt. People often end up in financial difficulty because they apply for the maximum levels of debt they can afford and a few months later when interest rates increase, they can no longer afford the increased instalment.

Different forms of debt have different interest rates. Take into account the interest rates and repayment periods of a credit card, personal loan and overdraft when you need short-term funding. The option with the lowest interest rate is most likely the best option, but also consider the terms and conditions.

Get quotes from other banks and institutions when applying for a home loan or car financing. Paying 0,25% or 0,5% less interest can make a significant difference over a longer repayment period like 20 to 30 years on a home loan or 5 years on car financing. Buying a car or home is a big decision and every little bit of interest that you can save is worth it.

Read the contracts in detail. Some loan contracts contain a penalty clause when you are repaying the loan within a shorter period than the initial period agreed upon. Look out for these type of clauses. You want to be in a position to repay your loan in a shorter period without having to pay severe penalties.

Interest rates on debt are always higher than what you will be earning on investments. When you urgently need money for something that you haven’t budgeted for, consider to rather use some of your investment money to pay for it. The interest that you will be losing is much less than the interest you would be paying for the debt; leaving you in an overall better financial position.

 Written by Ronel Jooste

CA(SA), Financial Consultant and Coach, Blogger and Speaker

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