MONEY

'Lower Monthly Payments Are A Myth -- It's Never Cheap To Buy On Credit'

Interest rates are the devil.

19/10/2017 16:15 SAST | Updated 24/10/2017 17:45 SAST
Pawel Gaul

Just because monthly repayments are significantly lower than the amount you'd pay upfront does not mean it's "cheaper" to buy on credit.

"If we focus only on the impact on our immediate monthly finances, it does look like buying on credit is the more affordable option," said Andrew Davison, head of investment consulting at Old Mutual Corporate Consultants.

He cautioned, however, that this is a huge misconception.

"If you take a step back and consider the impact on our finances over the full period of the loan, then it becomes very obvious just how expensive debt can be," he told HuffPost SA.

He illustrated it this way:

Ruth's current salary is R 5,000 per month (after deductions) and she wishes to buy a dining room table for R25,000.

She has two options:

Option 1: Take a loan

-Pay R900 per month in repayments over 36 months, with an interest rate of 18%

-Total amount payable over the term of the loan: R 32,400

-Outcome: Ruth gets the table immediately BUT she pays a LOT of interest, R7,400 in total

Option 2: Save money and buy later

-Save R900 per month in a bank account with a good interest rate (8%)

-Increase this contribution in line with her salary increase (assuming 6%)

-After 28 months, Ruth can afford to buy the dining room table in cash

Outcome: Ruth waits a bit while she EARNS interest instead of paying it, R2,555 of interest in total.

The difference:

  • Ruth's money works for her instead of her working to pay off a loan.
  • At the end of three years, she has effectively had the benefit of a whole extra month's salary!
  • That's more than R5,000 for her to spend on other things or to save for the future.

"It's clear that taking a loan now for something you want could cost you more than a whole month's salary with interest," said Davison.

"Remember that the longer the loan repayment term and the higher the interest rate, the more interest you will pay and the greater the impact will be on your financial health," he concluded.

*Inflation would have pushed up the cost of the dining table after 28 months -- Davison built this into his calculations.