Various money ratios indicate if your debt is at a manageable level or not. These calculations may be employed by financial institutions to determine your creditworthiness but are generally helpful to understand your finances, reduce debt and improve budgeting.
Lenders measure your level of debt to determine your creditworthiness by calculating a debt-to-income ratio or DTI, meaning the portion of your total debt relative to your monthly income. The lower the debt, the better chance you stand to receive more credit on your next loan application.
Similarly, a savings-to-income ratio looks at the portion of your savings compared to your monthly income. In this case, a lower rate means that you are less likely to put money away while debt takes over a more considerable portion of your income.
A savings debt ratio is another way to show whether you’re likely to have money left over for saving after spending and servicing debt. This ratio puts into perspective saving versus credit and your ability to save money over debt-funded regular expenditure.
Consumer debt vs saving
The South African credit bureaus offer bleak statistics concerning the country’s average household debt-to-income ratio and overall savings. Before the pandemic, TransUnion data showed a high DTI of around 72% in 2019, which meant South Africans spend nearly three-quarters of their income on debt.
On top of it all, the low 3% overall savings rate told that South Africans prioritise spending and debt over saving for the future.
However, the pandemic may have altered these habits. According to bloomberg.com, the household debt fell for the first time in almost two decades in the second quarter of 2020 following pandemic restrictions, which affected consumer spending and savings.
Still, the household debt to disposable income ratio jumped to 85% in the second quarter of 2020 from 73% in the first quarter of the same year. While consumer debt may decrease overall, South Africans are still battling with higher than usual debt ratios.
Paying off debt vs saving
Accessing credit is completely normal to fund those essential purchases, e.g. a home or a vehicle, but incurring too much debt comes at the expense of a savings plan. This is why you need to be in control of your debt and learn to make sound financial decisions, such as reducing debt so you can increase your disposable income and start saving.
Looking at your credit report and enquiring about your credit score gives you a complete picture of the various loans and credit facilities taken to date and how well you manage them. Consider this your debt portfolio. From here, finding your debt-to-income (DTI) ratio determines your level of indebtedness and, subsequently, the opportunity or savings.
- Less than 35%: Your debt is manageable, and there is an opportunity for savings. Creditors view a lower DTI as favourable.
- Between 35% and 50%: You need to be careful about credit and manage your growing debt—less opportunity for savings.
- More than 50%: You may be heading to a dangerous level of debt and over-indebtedness—a low chance of saving money.
Balancing your savings versus debt portfolio improves your savings debt ratio. For example, if you lower your DTI to an acceptable level – 30%, and your monthly expenses sum up to 50% of your income, the resulting 20% disposable income can be used towards savings or paying off your debt faster.
Suppose your savings debt ratio is low or non-existent. In that case, it may be because you are over-indebted and cannot entertain the possibility of savings when you barely handle so many debt repayments. Pay off these outstanding debts first before focusing on savings. You may need debt counselling if you’re seriously drowning in debt.
Money-saving and debt consolidation
Debt consolidation or debt review is a formal process open to indebted consumers who struggle with multiple debt repayments. Taking this step towards paying off debt helps you secure more affordable loan terms with creditors and consolidate significant repayments into one easily payable debt. It also ensures you can free up some money from your income to use for other purposes than servicing debt.
Generally, a debt counsellor will develop a new budgeting plan, rethinking spending habits to reduce your debt-to-income. Consequently, reducing debt contributes to a higher disposable income and a lower debt-to-savings ratio.
Therefore, your debt counsellor can both act as a debt adviser and money-saving expert. By getting debt help through debt counselling, you enjoy the benefits of freeing up cash so you can start saving money and improve your financial future.
Need help with paying off debt? Consult an ezDebt counsellor today.
Our professional debt advisers can help you stay on track with debt repayments through quick and affordable debt counselling. All our debt counsellors are registered with the National Credit Regulator (NCR). Get in touch at www.ezdebt.co.za.