Hide your credit cards this festive season

As consumers brace for the festive season amid the current economic downturn, the South African Savings Institute continues to reinforce its Festive Savings Campaign. The campaign’s slogan: Stop! New Year Ahead is significant for consumers who have bonds, cars and school fees to pay.

What is interesting to note is that South Africa has one of the highest, if not the highest, interest rates in the world. While high interest rates may seem punitive they have definite benefits, such as promoting a savings culture in South Africa.

“A high interest rate means higher earnings on savings, higher return on investments as well as a move to savings and away from debt purchases,” explains Elias Masilela, chairman of SASI, “Buying on credit helps the banks and the retailers, but it does not help the consumer.”

Currently the interest rate is below the rate of inflation, in the negative real territory. In contrast with equities it can be concluded that our interest rate is not doing too badly.

It is also encouraging to note that South African consumers are spending less. Real household spending has slowed to 1.2% in the second quarter of 2008, led by a sharp decline in the demand for consumables. This means that people are increasingly drawing a distinction between needs and wants – something SASI actively encourages.

Unfortunately, this has been matched by a decline in the growth of disposable income which slowed to 2.6% in the second quarter. Both these variables had increased in excess of 6% in the first quarter of 2007 and to above 8% in the last quarter of 2006, the highest since 2003.

Leading the decline in durable consumer spending is the shift away from purchasing motor vehicles – sales have dropped to levels last seen in 2004.

Cash vs. Credit

When consumers save or invest, the interest works on their behalf, whereas credit purchases encourage consumers to live beyond their means.

However, for large purchases such as buying a home or a car, credit is almost always necessary. But, it is important that consumers remember to shop around for credit. Different banks offer different interest rates and specific benefits. The National Credit Act, formally implemented in 2007, requires all banks to be completely transparent with their charges. This means if consumers read the fine print they will be able to make an informed credit decision.

“It would seem like consumers are becoming more responsible and readjusting their spending. This is reflected in the growth of loans and advances which have slowed to levels last seen in 2004. Growth in loans and advances slowed to 15.6% in the third quarter from 23.6% in the first quarter and to above 25% in the first quarter of 2007,” Masilela explains.

Making an informed decision and paying less interest or money for unnecessary assets and goods can enhance one’s overall savings.

Hide your cards

Cash is king. The immediacy of a cash sale ensures the buyer does not have to worry about paying for the item in the future at a premium. There are no interest payments or other fees involved. The security of finalising a purchase with cash means that the buyer never has to worry about not being able to make a payment in the future. There are no payments outstanding and the new owner is free to enjoy their purchase.

“Having cash in hand also gives one huge bargaining power. Not only is one able to avoid a higher purchase cost but one may also pull off a cash payment discount. This is a double benefit for the consumer which coincides with immediate positive cash flow for the seller,” Masilela adds.

Credit cards can be useful in an emergency and some even offer added benefits such as air miles, travel discounts, special insurances and purchase discounts. However, beware as this is generally clever marketing to encourage spending. Consumers must make sure that credit consumption is well thought-out and sustainable.

Compare purchasing a car on credit versus purchasing a car for cash. If you buy a car for R200 000 through a bank at an interest rate of 17.5% (prime plus two), the monthly repayments will be R9936.56 over 24 months.

If you hold out and save 24 months you will be able to afford that R200 000 car and have saved enough money to be able to afford a more expensive car all the while spending the same amount of money.

Using your homeloan as a savings device can also save you a fortune by decreasing the amount of interest you owe.

For example, if you buy a house for R1.4 million your monthly repayments are R16 190 at prime -2 (14%). If you make an extra payment of R810 a month, you will save R500 000 over the period of your bond. Interest on a bond of 14% over 20 years means on your R1.4m house you will pay an extra R2.8m in compound interest over the period if you only pay the recommended amount a month. This means you will actually pay R4.3 million for your R1.4m house and that is only if the interest rates don’t rise.

Both examples show how using cash rather than credit on large purchases will save you a lot of money and create wealth.

“All consumers should review the need for getting into debt before committing,” Masilela advises, “If the debt is necessary, ensure it is affordable and yields a positive return. Once in debt, consumers need to works towards paying it off as soon as they can. This will minimise the overall costs of the credit, encourage savings and lead to an accumulation of assets.”

Slumping into 2009

The economic slump has effected more than business and job security. Consumers’ budgets are squeezed and they are looking at their money differently. Delaying purchases, trading down and buying less often are a few ways to make the pennies last.

The economy has already slowed down, disposable income is declining and prospects of job shedding are increasing as the demand for commodities decline. These should be strong indicators for people to start managing their money and spending differently.

Not paying bills and living off expensive credit will only make things worse. Especially as we head into 2009, a year that will most certainly have a few financial surprises in store for all consumers.