What is debt?

This is the second in a series on debt and how it can effect you. The previous post dealt with SA’s junk status and can be read here.

In its broadest sense, the idea of a “debt” refers to an obligation to do something, whether by payment or by the delivery of goods and services, or not to do something.  For the purposes of this series, we will focus only on the obligation to repay money.

South Africans are no strangers to borrowing money.  In 2014, the World Bank Findex reported that a higher percentage of people in South African borrowed money than in any other country in the world.[i]  “Borrowing” could mean borrowing from financial institutions, from friends and family, from stores (buying on credit) and from private informal lenders.  These are all types of debt.

Whatever the case may be, if you have debt, or are thinking of borrowing money, there are some important things you need to consider:

  1. Whether the debt will be secured or unsecured;
  2. What your interest rate will be; and
  3. How many repayments you will be required to make.

In this post we will discuss some of the common types of debt and what makes them different from one another.

Common types of debt

Secured versus unsecured debt

Secured debt is when the person you borrow money from has some sort of claim to your assets if you don’t pay them back.[ii]  Home loans are a good example of secured debt.  On the other hand, unsecured debt is debt without any collateral or security.  A personal loan from a bank is unsecured.  Because secured debt is less risky, lenders will usually offer better interest rates for secured debt compared to unsecured debt.

Home loans

For many people, buying a home or land is the largest financial investment they will make over the course of their lives.  A home loan is a loan given by a financial institution for the purchase of a house. They will give you enough money to buy the house today, if you agree to pay off the loan with interest in small amounts over a number of years.  As it is such a large amount of money, the financial institution will usually require that the loan be secured by a mortgage bond over the property.  This means that your house is the collateral for the loan, and can be seized by the bank if you fail to pay your debt.

What is a mortgage bond?

A mortgage bond is a legal instrument which is registered against the title deed of immovable property.  It gives the bond holder something called a “real right” over your property.  This prevents the owner of the property from selling the property without the permission of the bond holder, and allows the bond holder to sell the property if the owner fails to pay their home loan repayments, as agreed.

A bond comes into being when you sign bond documents with the bank or the bank’s attorneys.  On a practical level, it is a note on the Deeds Office records that someone else has a real right over your property.

Car finance

You can finance your car through a financial institution in one of two ways: an instalment sale agreement, or a lease sale agreement.  In both cases, the bank will own the car until you pay off the loan. Once you have made all the payments on an instalment sale agreement, you become the owner of the car.  In the case of a lease sale agreement, you get the option to buy the car once the agreement has run its course.

You should always be wary of the fact that cars lose value over time.  So, if you buy a car and need to sell it in a year’s time because you can no longer afford the repayments, it is possible that you won’t make enough money from the sale to repay everything you owe.

Personal Loans

A personal loan isn’t secured against anything you own. Unsecured loans are riskier than secured loans because it is less certain that the lender will get their money back if you fail to pay the loan repayments. To cover the risk, the lender will usually require a higher interest rate.  Where you might get a home loan at 2% “above prime”, you could get a personal loan at anything from 5% to 20% above prime. In real monetary terms, that means you are paying a lot more for the debt.

Although it is a riskier form of debt, this does not mean that the lender can’t get their money back.  A lender will still be able to enforce the agreement through the courts and the mechanisms in the National Credit Act 34 of 2005.

Payments by monthly instalments

Think of all of those adverts you see which tell you that you have the choice of paying for a product today, or paying a number of smaller payments over a number of months (TVs, furniture and cell phone contracts). If you choose to pay off the item over a number of months, you will have a contractual obligation to make those payments and, if you default, the store that you bought the item from will be able to take legal action against you for breaching that contractual obligation.  This could involve reclaiming the item, cancelling the contract, and/or claiming damages against you.  You will usually end up spending much more for the product than you would have if you had saved up and bought it cash.

Private informal lenders

Borrowing from informal lenders is common in South Africa.[iii]  Private informal lenders are unregulated and, as such, may charge much higher interest than formal lenders. If you are borrowing informally, make sure that you know what interest will be expected from you.  Be careful of lenders that don’t agree to repayment terms and interest up front, as you could end up repaying many times what you borrowed.

Debt traps

A debt trap is the term used to describe a situation where a person has debt that is extremely difficult or impossible to repay.  One of the ways in which you can fall into a debt trap is when you start borrowing from other institutions, or from informal lenders, to repay the debt you currently have.  It becomes a downward spiral when the new debt is on worse terms (higher interest) than the old debt. The further into debt you get, the closer you get to being blacklisted, declared insolvent and having your assets sold to repay your creditors.

Good debt management

Debt can be a very useful tool for buying assets or financing your dreams, but it can also be a quick way to lose a lot of the things you have worked so hard for.  Being aware of how debt works and how to manage it is crucial if you are going to rely on debt to help you to reach your goals.

When you take out debt, remember that interest is the cost of that debt.  The higher your interest rate, the more you are spending to get debt. The lower your interest, the cheaper your debt – always aim to get the lowest interest rate you can. One of the ways that a financial institution will determine what your interest rate will be, is to consider your credit rating.  When you default on your payments (make late payments or no payment at all), your credit rating goes down. This will make your future debt more expensive and possibly lead to your eventual blacklisting. When you pay your debts according to the terms of your agreement, your credit rating improves. The better your credit rating, the more likely you will be offered better interest rates in future – always try to stick to the terms of your contracts.

In our next part of this series, we will deal with the issue of interest rates and inflation and how this affects debt.

By: Alexander Ashton

Alexandra Ashton is an attorney heading up the LRC Johannesburg debt and housing department. She holds a BCom and an LLB with distinction from Wits University. 

Alex, with thanks to the continued financial support of Legal Aid South Africa, is currently working on assisting people who lost their homes as a result of the fraudulent Brusson Finance lending scheme to be restored ownership of their properties.

Disclaimer: The opinions expressed by the Realising Rights bloggers and those providing comments are theirs alone, and do not reflect the opinions of the Legal Resources Centre. The Legal Resources Centre is not responsible for the accuracy of any of the information supplied by the bloggers.

[i] According to the World Bank, Global Findex Data Bank, (available at: Databank.worldbank.org/data/reports.aspx?source=1228) 85.6% of South Africans had borrowed money in the year leading up to the report compared to the global average of 42%.  See also Demirguc-Kunt et al, “The Global Findex Database 2014: Measuring Financial Inclusion around the World” at page 7 available at: http://www.worldbank.org/en/programs/globalfindex.

[ii] A secured loan is defined in the National Credit Act No.34 of 2005 as “an agreement, irrespective of its form . . . in terms of which a person advances money or grants credit to another, and retains, or receives a pledge to any movable property or other thing of value as security for all amounts due under that agreement”.

[iii] The 2014 World Bank Findex Data Bank recorded that 10.9% of South Africans have borrowed from informal lenders.

How the ratings downgrade affects your debt: a legal perspective

[Featured image sourced from BusinessTech]

As of today, 07 April 2017, both Standard and Poor’s (S&P) and Fitch, two of the three international ratings agencies alongside Moody’s, have downgraded South Africa’s credit rating to sub-investment grade, or “junk status”. There has been a lot of discussion about how this could affect the exchange rate, international investment, taxes and government spending. But how does it affect the average person and what, from a legal standpoint, should you be aware of?

Before we start, it is important to note that there is no need to panic. Economic changes don’t usually happen too drastically, or overnight. Nonetheless, there are things that you should do to prepare yourself so that you are not caught financially off-guard by changes as they happen.

So what can the average person expect? The average person could be affected in five ways: taxes may increase, interest rates may increase, inflation may increase, job security may decrease and returns on your pension, provident and retirement funds will probably decrease. What this boils down to is more pressure on your pocket. That pressure will make it harder to save, invest, and – more critically – make it harder to repay debt and cover your day-to-day expenses. In this post we are going to focus on what happens when you can’t pay back your debt.

First of all, what is debt? Debt is when you have effectively borrowed someone else’s money that you need to pay back. Debt can take a number of forms. Home loans, vehicle finance, credit card debt, personal loans, store cards, cell phone contracts, and instalment sales are all forms of debt. With the pressure of interest rate increases and rising costs of expenses, it becomes harder to make your monthly repayments. If you don’t or can’t pay your monthly instalments, your credit provider can take a number of legal steps against you depending on you contract with them and the nature of the debt.

Ultimately, the law recognises a creditor’s right to be paid for what they have lent you. So if you stop paying, you don’t simply get to walk away without repercussions The law provides a number of ways for creditors to get their money back. Ultimately, each way puts your belongings and, sometimes, your livelihood and home at risk. Common legal routes to recoup unpaid debt are as follows:

  • Bonds over your immovable property (mortgage bonds) allow credit providers to sell off that immovable property to repay themselves. You might have a home loan secured by a mortgage bond over your house for instance.  If you default, the bond would allow the bank to sell your home.
  • Writs of execution allow creditors to sell your movable property (for example your car or furniture), and or your immovable property to pay themselves back.
  • Garnishee orders / emolument attachment orders allow a creditor to deduct money straight off your salary.
  • Orders of insolvency allow creditors to sell off your assets to repay themselves.

Over and above all of this, defaulting means that you run the risk of being black listed. If you are black listed you won’t be able to get credit in future. If you avoid black listing, you may run the risk of having your own personal credit rating downgraded. Just like the S&P downgrade, this will make credit institutions less inclined to lend you money, and if they are willing to lend you money, it will more than likely be at interest higher rates.

So basically, you need to avoid defaulting on your debt.

What you as a consumer and a debt holder can do to avoid default is to first and foremost “know your debt”. In other words, know exactly how much you have borrowed, and exactly how much you have to pay back on a monthly basis.

Secondly, “know your interest rates”. You need to know which of your interest rates are flexible and take steps to understand what an increase in the repo rate will mean for each of your repayments. Most debt is granted on a flexible interest rate. What this means is that if the reserve bank chooses to increase the repo or “prime” lending rate (which is likely to happen following a downgrade) your interest rate will also be increased.

Thirdly, “have a plan to reduce your debt”. Have a plan of how you are going to repay your debt. The best place to start to reduce debt is try to reduce your expenses and to use any extra money you have – after paying off your monthly repayments – to pay off your debt starting with the debt with highest interest rate.

Fourth, “try to avoid more debt”. Particularly avoid debt on medium-sized purchases and purchases you don’t need. That new TV may only cost you “R199 per month!!!” But that is adding to your debt burden, your risk of default, and usually, you will end up paying more for that TV over the long run than you will if you save up and buy it in a lump sum. Yes, this means you may not have as many nice things. But if interest rates increase you will be grateful that you are not drowning in debt.

Fifth, “downsize if necessary”. Do you really need that expensive car, that expensive house, or that fancy cellphone? Think about going simpler, smaller and cheaper. When it comes to debt, every little bit counts.

I hope this basic overview has been helpful. Over the weeks to come, we are going to run a number of articles on our “Realising Rights blog” to unpack the concepts set out in this article with the aim of helping you take control of your debt.

By Alexandra Ashton

Alexandra Ashton is an attorney heading up the LRC Johannesburg’s debt and housing department. She holds a BCom and an LLB with distinction from Wits.

Alex, with thanks to the continued financial support of Legal Aid South Africa, is currently working on assisting people who lost their homes as a result of the fraudulent Brusson Finance lending scheme to be restored with ownership of their properties.

Disclaimer: The opinions expressed by the Realising Rights bloggers and those providing comments are theirs alone, and do not reflect the opinions of the Legal Resources Centre. The Legal Resources Centre is not responsible for the accuracy of any of the information supplied by the bloggers.