PERSONAL FINANCE: The debt catch up

Have you ever been in the middle of a movie and then had to step out for one reason or the other? Maybe it was to take a phone call, make a snack or finish a chore. When you get back to the movie, you find you’ve lost track of the storyline and so you spend the remaining time playing catch up. You start irritating others who were watching the movie by asking what happened.

This week we tackled debt in our class. One of the students said she feels like she is playing catch up with her debt. Just as with the movie, her life was interrupted by a loan she took, and she is now trying to catch up to a place where she can afford the loan – or even go back to life before the loan.

Like many people, she did not really understand the implications of that loan. Maybe you can relate to that. You took out a loan or a series of loans and you now wish you never had. You thought you could handle it; it looked good on paper, but now realise you can’t afford it. Let’s look at some of the things that put us in this situation through the story of Susan.

Susan* took out a car loan for Sh2 million. The bank looked at her pay slip and decided she could afford it. Banks do this by ensuring that your monthly repayment does not exceed a certain percentage of your salary. This is referred to as a Debt to Income Ratio.

Susan’s car repayment ended up being 50 per cent of her income.

The bank calculated this regardless of her other financial obligations. Susan now realises that to comfortably afford the loan, she needs to be earning 30 per cent more than she is now. She needs her income to increase just to afford a loan that she has already taken.

Can you see the irony in that?

Ideally, this increase should go towards Susan’s savings and investments. However, because it is going towards her loan, it will never quite feel like the increase it is. In case you are wondering, I told Susan to sell her car, pay off the debt and buy a less expensive one.

There are many people playing the same sort of catch up in different ways. Credit card payments, holiday loans, school fees… we’re going into debt to pay these off.

Many buy things they can’t actually afford because they don’t want to risk their image. However, borrowing to live a lie is expensive. Susan, for example, will end up paying an extra Sh1 million to the bank in interest. When we are consumed with the here and now, we do not realise the impact of our actions in the future. If Susan invests that Sh1 million, it will be worth Sh10 million in 20 years. This may be money she can use in her retirement years.

When she retires, she may realise that her portfolio needed that Sh10 million to cater for her.

Many people often realise when it is too late that one bad decision may have cost them future comfort. Now they have to figure their way out of a bad situation. Bad debt has the ability to freeze time. You may look good in your nice car or in your exotic holiday pictures, but in reality, you don’t move forward.

You feel stuck.

It’s even worse when we keep borrowing one loan on top of another. You can end up playing catch up all your life. When you borrow be very clear about it. Take time to do the calculations so that you don’t end up in a catch up situation. Evaluate that loan properly based on your income but also the opportunity cost.

Don’t let debt rob you.

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