What is Bad debt?

Firstly, you need to understand that there is a difference between good and bad debt. By this statement obviously not all debt should be considered as bad. To distinguish between the two is relatively simple. Bad debt takes money from you and will make you poor. Good debt is debt which someone else pays for you, and bad debt you pay for. If you think I mean that good debt is your clothing account which your spouse pays, you are on the wrong track.

An example of good debt is a bonded rental property, but your rental income covers the bond instalments and expenses. Bad debts are credit agreements such as personal loans, credit cards, vehicle loans, clothing accounts, overdraft facilities etc.

Before you attempt this, beware!

Getting rid of bad debt is not as simple as you think, but very achievable for those committing to the process. Should you be married or have a life partner, this is something you need to discuss with your other half as if you are not both fully committed hereto, you will not achieve the desired results. Too often I see only the one spouse being committed to the household’s strive for financial freedom, which could have devastating results such as divorce. This is not a decision that should be taken lightly and requires the commitment and support of all parties involved.

Step 1 – Draft a budget

Before you can set off on your journey to liberation from bad debt, you need to know where you are. Draft a budget which includes all the income and expenses of your household.

Here is how to plan a proper budget in 5 simple steps.

When drafting your budget, always keep your bank statement on hand to see exactly what you spend your money on throughout the month. This is an eye opening exercise and you need to be honest with yourself to identify wasted expenditure. In order for you to improve your financial position, you will need to make lifestyle changes. There is absolutely no reason for you to have a life insurance policy on each family member in your family tree, or have five cell phone contracts. Get rid of wasted expenditure and keep your end goal in mind.

Now that you know what your necessary monthly budget is, you need to write down all your creditors as follow:

CREDITOR NAME ACCOUNT TYPE ACC NUMBER BALANCE INSTALMENT
ABC BANK CREDIT CARD 123456789 R 128,431.37 R 3,800.00
DEF LOANS PERSONAL LOAN AB555001 R 32,058.19 R 1,400.00
GH BANK BOND ACCOUNT 987654321 R 481,999.80 R 4,200.00
JKL CLOTHING CLOTHING 852741963 R 3,521.20 R 550.00
XYZ SHOES CLOTHING 2468 R 1,782.55 R 330.00
MNO BANK PERSONAL LOAN 654321 R 8,499. 75 R 680.00
GH BANK CREDIT CARD 951753 R 13,589,64 R 750.00
QRS FURNITURES FURNITURE ACC 147852 R 19,777.33 R 1,280.00
DR. PET INCIDENTAL 13579 R 450.00 R 150.00
DR. KID INCIDENTAL 97531 R 1850.00 R 350.00
TOTALS R R

Looking at this will give you an excellent idea of what your overall financial position is and you are ready to move on to the next step.

Step 2 – Identify debts to settle first

Using the above creditor schedule you have drawn up, decide which of these debts you wish to settle first. I usually suggest settling the one with the smallest outstanding balance, first. In order to draft a visual list of which debts you are going to settle first, rank those starting from the first creditor you want to settle first to the last.

The table belwo works even if you are not overindebted and are just looking for a way to do some debt management to avoid being overindebted.

CREDITOR NAME ACCOUNT TYPE ACC NUMBER OUTSTANDING BALANCE MONTHLY INSTALMENT RANKING
ABC BANK CREDIT CARD 123456789 R 128,431.37 R 3,800.00 9
DEF LOANS PERSONAL LOAN AB555001 R 32,058.19 R 1,400.00 8
GH BANK BOND ACCOUNT 987654321 R 481,999.80 R 4,200.00 10
JKL CLOTHING CLOTHING 852741963 R 3,521.20 R 550.00 4
XYZ SHOES CLOTHING 2468 R 1,782.55 R 330.00 2
MNO BANK PERSONAL LOAN 654321 R 8,499. 75 R 680.00 5
GH BANK CREDIT CARD 951753 R 13,589,64 R 750.00 6
QRS FURNITURES FURNITURE ACC 147852 R 19,777.33 R 1,280.00 7
DR. PET INCIDENTAL 13579 R 500.00 R 150.00 1
DR. KID INCIDENTAL 97531 R 1850.00 R 350.00 3
TOTALS R R

Now you have a list of creditors ranked from number 1 to 10 and visualise these as stairway steps to your end goal, being free from bad debt.

Step 3 – Now let the payments begin

After reassessing your budget, see if there are additional funds you can make available for debt payments. Each month you only pay the minimum instalments to each creditor. The additional funds, if any, must be allocated to the smallest creditor. Do not divide the additional funds amongst more than one creditor. The idea is to follow a structured repayment plan settling debts one by one as per your ranked list.

In this example, you are able to make an additional R100 available from reducing one of your budgeted expenses.

Settling creditor #1

You will pay the minimum monthly instalment on all your creditors, except for creditor #1, Dr. Pet. This creditor will be paid as follows:

  • Minimum instalment 00
  • Extra R100 from budget 00

– Total payment  R250.00

Continue with this until you have settled creditor #1.

Move on to creditor #2

CREDITOR NAME ACCOUNT TYPE ACC NUMBER OUTSTANDING BALANCE MONTHLY INSTALMENT RANKING
ABC BANK CREDIT CARD 123456789 R 128,431.37 R 3,800.00 9
DEF LOANS PERSONAL LOAN AB555001 R 32,058.19 R 1,400.00 8
GH BANK BOND ACCOUNT 987654321 R 481,999.80 R 4,200.00 10
JKL CLOTHING CLOTHING 852741963 R 3,521.20 R 550.00 4
XYZ SHOES CLOTHING 2468 R 1,782.55 R 330.00 2
MNO BANK PERSONAL LOAN 654321 R 8,499. 75 R 680.00 5
GH BANK CREDIT CARD 951753 R 13,589,64 R 750.00 6
QRS FURNITURES FURNITURE ACC 147852 R 19,777.33 R 1,280.00 7
DR. PET INCIDENTAL 13579 R 500.00 R 150.00 1
DR. KID INCIDENTAL 97531 R 1850.00 R 350.00 3
TOTALS R R

Now that you have settled your first creditor, you have reached the first goal to freedom from bad debt. In order to pay creditor #2 off sooner, you are going to pay the minimum instalment plus the FULL amount you paid to creditor #1.

  • Minimum creditor #2 instalment 00
  • Creditor #1 minimum payment 00
  • Extra R100 from budget 00
  • Total creditor #2 payment 00 Continue these payments until you have settled creditor #2 in full. Move on to creditor #3
CREDITOR NAME ACCOUNT TYPE ACC NUMBER OUTSTANDING BALANCE MONTHLY INSTALMENT RANKING
ABC BANK CREDIT CARD 123456789 R 128,431.37 R 3,800.00 9
DEF LOANS PERSONAL LOAN AB555001 R 32,058.19 R 1,400.00 8
GH BANK BOND ACCOUNT 987654321 R 481,999.80 R 4,200.00 10
JKL CLOTHING CLOTHING 852741963 R 3,521.20 R 550.00 4
XYZ SHOES CLOTHING 2468 R 1,782.55 R 330.00 2
MNO BANK PERSONAL LOAN 654321 R 8,499. 75 R 680.00 5
GH BANK CREDIT CARD 951753 R 13,589,64 R 750.00 6
QRS FURNITURES FURNITURE ACC 147852 R 19,777.33 R 1,280.00 7
DR. PET INCIDENTAL 13579 R 500.00 R 150.00 1
DR. KID INCIDENTAL 97531 R 1850.00 R 350.00 3
TOTALS R R

The same principle applies as the other two creditors.

  • Minimum Creditor #3 instalment 00
  • Minimum Creditor #2 Instalment 00
  • Minimum Creditor #1 Instalment 00
  • Extra R100 from budget 00

– Total Creditor #3 Instalment  R930.00

Use this formula until you have settled all your unsecured debt. Unsecured debt is all your credit agreements excluding your bond account. This escalating payment plan will result in a change of mind- set, learning to budget and living within that budget, in the end reaching your goal of financial liberation.

Once you have settled all the unsecured credit agreements, keep your bond on an increased instalment to settle it sooner, and allocate the balance of the available funds to an investment.

Be sure to share your success story with us and others.

Debt Review Centre - 2022