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When Does Debt Become a Debt Problem?

In this blog, we will look out how and when debt becomes a problem, the different types of debt, and what you can do to help improve your finances.

What’s the difference between “good debt” and “bad debt”?

Good debt is debt that is used to enhance your wealth. You may take out a loan to purchase something that will boost your monthly income, or its value may increase over time, allowing you to make a profit if you sell the item in the future. In addition to this, good debt may be viewed as a loan used to acquire something that has a productive value, such as buying a car to travel to work and supporting your family.

Bad debt, then, is the opposite of this. Bad debt is debt used to purchase something that will not enhance your income, will not grow in value over time, and has little to no productive value.

Sometimes, it’s not always crystal clear. What bad debt is for some may be good debt for others. For example, buying a gaming console and some video games on a store card would be bad debt.

But if that same retailer bought a large number of consoles and games from a warehouse on credit to sell in the shop, that would be good debt. Why? Because the retailer will likely make a profit on those items, allowing them to clear their debt with profit left over.

This is the essence of good debt: it is debt used to generate future returns. Other forms of good debt may include a mortgage to buy a house; a loan to start or invest in a business; money used to invest in commodities or financial assets; and money lent to businesses for an agreed interest rate, such as peer-to-peer lending. All these types of investing carry significant risks.

An important point to note is that it is only considered good debt if the growth in value or income from your asset outweighs the cost of your loan — if it does not, then it is bad debt because the cost of your loan will be more than what you are making from your investment.

 What Is Problem Debt? 

Problem debt is when your monthly income struggles to meet your monthly outgoings. No matter how much we earn, whether it is R1,000 per week or R5,000 per week, there will always come the point when debt becomes a problem.

If you find that a large part of your income goes straight back out to pay off your recurring debt, this is problem debt. The best solution is to pay this down as quickly as possible. The issue with problem debt is that it can quickly spiral out of control — it may only take a one-week holiday and a few missed payments for your debt to become unmanageable.

Your debt can also be considered a problem if it impacts your well-being. Debt can affect us all differently; some of us can feel comfortable owing quite large amounts, others can feel stressed and worried over the smallest amount. Therefore it is important to consider how you respond to debt.

If debt makes you feel stressed and worried, then clearing your debts may be the best option to take that worry off your mind. If you are comfortable with debts, you will also need to be very cautious because you may allow yourself to take on too much of a burden.

How Do You Deal With Debt Problems? 

One of the best ways to start resolving debt problems is to begin tracking your monthly financial inflows and outflows. It is easy to lose track of what you are spending, leaving you with the impression that you have not overspent. This could be a justification for purchasing that dress or that new phone on your credit card — but if you were aware of precisely how much you had spent, you might think twice.

This is why tracking our finances is so helpful. It puts us in control, like a business finance manager, allowing us to scrutinise every expense. Instead of basing your spending on a whim, base your spending on a budget, this is far more productive. You can set aside precisely what you need for your bills, for shopping, and even for savings and investments.

How Much Debt Is Normal? 

Some people have a lot of debt, some people have little debt, so there is no normal amount of debt. A better question to ask is, what is a reasonable or manageable amount of debt?

When you apply for a mortgage, one of the things the bank will want to check before accepting your application is affordability: based on your current income and expenses, would you be able to pay the additional cost of your mortgage each month?

You can use a simple ratio to figure out what percentage of your monthly income goes towards recurring debts. It is called the debt-to-income ratio, and it works like this: recurring monthly debt / gross monthly income = debt-to-income ratio.

For example, let’s say you pay R10,000 per month on your mortgage, R3,000 on your car loan and R3,500 on credit cards, and you earn R25,000 per month.

(10,000 + 3,000 + 3,500) / 25,000 = 0.66

This means that 66% of your income is being spent on recurring debt. Keep in mind that there will be other monthly expenses, such as food, clothing, household bills, car fuel, and repair bills, which vary from month to month.

Most financial advisors recommend that a good percentage is 35% or less spent on recurring monthly debts. If your debt-to-income ratio is higher than this, then it is best to try and get it down as soon as possible.

Where Can You Get Help If You Have Debt Problems?

At Debt Movement we understand that bad debt happens to good people. We know the stress, anxiety and sleepless nights which come with being overwhelmed by debt.

Our commitment is to provide the best service to our clients, helping them to manage their debt, showing compassion and earning their trust. We journey together with our clients guiding them to their financial freedom, so that they can live their best lives again.

We have a team of well-trained debt experts and debt counsellors ready to assist our clients in securing an affordable, personalised, monthly payment which will cater for all accounts. Through Debt Review, a government legislated process that forms part of the National Credit Act, we help South Africans reduce their debt repayments by up to 50%, end debt collector harassment, and legally protect their assets from repossession.

Call us on 031 010 0509, or request a free call back.