Debt. To some it means death, and to others, it can be a lifeline. Regardless of what your opinion is on debt, it is very important to be informed about how it works – and how you can ensure that it works for you.
According to Statistics South Africa, the local debt-to-income ratio is close to 75%, which means that for every R100 a family earns, R75 of that will need to be paid to creditors. In addition, the National Credit Regulator (NCR) estimates that 60% of consumers struggle to make their monthly debt repayments.
To combat this, the credit regulators have put measures in place to protect consumers, although most consumers do not make the effort to understand the world of credit.
Need debt to make debt?
Consumers often feel that if they have no debt, it should be viewed as a clear indication that they are creditworthy and should be given any amount of debt they require. However, from the credit provider’s perspective, this is not always true. Thinking that no debt is an indication of creditworthiness, is like saying: “Of course I can fly a plane. I’ve never crashed one, so I must be a good pilot.”
The question is: What will happen if a consumer applies for credit, but does not have any previous record of debt? These consumers are often referred to as ‘new to market’ and most of them are generally young customers applying for credit for the first time. Where such a case arises, the credit provider needs to rely on the information available to them to make the decision.
While each credit provider’s strategy will differ, the most common route will be to follow a prudent approach with a new customer until the customer has proven themselves over a period of time. A customer could be approved for a personal loan, but the loan amount could be kept to a certain predetermined level. After a period of time, when the client has proven themselves, the credit provider might decide to grant a new loan that is bigger than the original loan, if the customer requires this.
Credit provider decision
Credit providers mainly use three methods to determine the amount of money they are willing to lend to an individual. The first process is to use past performance with regards to credit, where individuals are assessed based on their recent performance relating to debt.
Credit providers will source information from the credit bureaus, which keep a record of all credit information relating to credit consumers in South Africa. This could mean that if I have a credit card at bank A that is overdue, bank B will be able to see this information when I’m applying for a mortgage loan from them, and might decide not to grant me this loan.
Credit providers can also use internal information to decide to refuse credit. This could happen where a consumer’s credit card is overdue at a bank, and then the same bank decides not to extend any further credit to the individual. Other internal information, such as returned debit orders or the utilisation level of an overdraft, can also help the credit provider to decide.
Finally, credit providers are required by law to ensure that a consumer is not over-indebting themselves before granting credit. This is done through a process whereby the credit provider needs to check if the consumer can afford the ‘new’ line of credit. Credit providers will ask for a statement of income and expense to verify that the consumer will have a sufficient amount of funds left to repay the credit.
Role of the credit bureaus
Credit bureaus fulfil an extremely important function in the credit lifecycle. They are governed by the NCR which was formed in 2005. The NCR is responsible for the regulation of the South African credit industry and aims to improve co-operation between credit providers as it is in all credit providers’ interest to know when a consumer has a poor record of payment with other providers.
All credit providers are required to supply account and payment information to all registered credit bureaus on a monthly basis. The credit bureaus collate this information and are then in a position to give an industry-wide view on a consumer when there is a new application for credit. The credit provider can use this view to determine if they deem a consumer ‘creditworthy’ before extending credit to them.
The credit bureaus are dependent on the information provided to them by all the different credit providers. While this process works efficiently for most consumers, it can happen that incorrect information is given to the credit provider relating to a specific consumer. Consumers can obtain their credit report from the credit bureaus upon request, and should aim to do so at least once a year.
If a consumer finds that the information at the credit bureau is incorrect, they can follow a dispute process to have this corrected. This could require the consumer to provide proof of the correct state of affairs.
When a consumer becomes unable to meet their credit repayment requirements, this will have an adverse effect on their credit profile. While it is unfortunately true that some consumers over-indebt themselves, a sudden loss of income due to financial difficulty (e.g. retrenchment), can also be a cause. When this happens, it is important to contact the credit provider immediately and explain the situation.
Credit providers are often willing to try and accommodate their consumers as far as possible, although they are not required by law to do so. By phoning your credit provider and explaining to them what your situation is, credit providers will attempt to reduce your instalments (within the ambit of their credit policies) normally through restructuring your debt over a longer period, or reducing the price you have to pay or through any other way they see fit.
Most credit providers will also offer you the option of credit life insurance. Depending on the type of insurance, it can pay out if you are disabled, retrenched or deceased.
When the credit provider is unwilling or unable to reach an agreement with the consumer, the consumer can apply for debt counselling. Debt counselling is a formal, regulated process that provides consumers with a legal option of dealing with over-indebtedness.
A consumer can apply for debt counselling through a debt counsellor. The debt counsellor will get a consolidated view of the consumer’s debt and agree with each of the credit providers on an amount that will be paid over a predetermined period until the consumer’s debt has been repaid. If the credit providers agree, the consumer is placed under debt counselling and this is noted to the credit bureaus. If one of the credit providers does not agree with the proposed terms, the matter is resolved in court.
Consumers under debt counselling are not allowed by law to be granted any new credit. Once all debt has been repaid, the consumer can apply for a clearance certificate from the courts, upon which the consumer will be removed from the debt counselling list at the credit bureaus.
Good vs bad debt
Debt can be a pitfall to some consumers, but it can also be a very useful and necessary tool to others. Determining if debt is good or bad can be very tricky and some guidelines can help:
- Do not use debt to fund a lavish lifestyle. Getting credit to fund a lifestyle above what you can afford is not sustainable and will only lead to less disposable income in the future.
- Do not fund credit with credit, e.g. using an overdraft or card to pay a personal, vehicle or home loan.
- Minimise your unsecured debt, especially short term (less than six months) lending; the interest component is extremely high.
- Refrain from taking credit for any other reason than what it was intended for. If you want to buy a car, then get a vehicle loan. Don’t get a personal loan to buy your car. You will end up paying much more as a personal loan will not take the asset value into consideration through the interest rate you’ll be paying.
- Be very honest when applying for credit. In South Africa, the regulation around the granting of credit is top-notch and is mostly aimed at protecting the consumer. This regulation, however, only works when consumers are honest. If you need to be dishonest in order to get the credit, you don’t actually have the means to repay the credit once it is extended. This will cause you to run into trouble very soon and the law will not be able to protect you.
- Know what you are getting yourself into. Consumers should take the time to understand the terms and conditions when accepting credit. This means knowing what you will pay every month towards interest, reducing your capital and fees.
- Good debt – for secured products such as home or vehicle loans, always provide as much security (assets, deposits, etc.) as possible – not only will this improve the likelihood of getting credit, but it will also reduce the price you’ll have to pay.
- Pay off debt as quickly as possible, starting with unsecured debt. This will mean you delve capital quicker and pay less interest over the period.
- Know your debit order dates and amounts. As the consumer, it is your responsibility to ensure your debit orders go off. Subscribe for notifications, and/or check your bank statements regularly. – Johan du Pisanie, Absa
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