Pay down debt, but be smart about it – Imara

The financial crisis has provoked a radical reappraisal of debt levels by many families, but the knee-jerk reaction to pay off all debt should be informed by an appreciation that not all debts are the same. Some should be tackled first.

The tip comes from Imara Asset Management South Africa, a wealth management company that advises many middle class families as well as high net worth individuals.

There is bad debt and good debt, says managing director Lara Warburton.

Credit card debt falls into the first category and energetic steps to reduce these obligations are well motivated as interest rate charges can be onerous, says Warburton.

However, bond repayments on a second rental property can partly be deducted from rental income for tax purposes – this is good debt.

“The financial crisis was a wake-up call for many families,” says Warburton, “and the reduction of previously high debt levels is often urgent. But not all gearing is bad and not all debts are the same.”

Imara Asset Management South Africa, a member of the Pan-African Imara Group, advises a thorough review of assets, debts and objectives by a well qualified financial planner. This will reveal where debt ‘sits’ and the debt-reduction priorities.

Warburton explains: “Your two principal debts might take the form of a R350 000 mortgage on your primary residence – the home you and your family live in – and a R350 000 mortgage on an investment property on which you derive an income.

“The financial numbers may be the same, but these two debts do not have the same characteristics. Repayments on one can be offset against income. Repayments on the other cannot.

“Factors such as this should be considered when deciding the priorities of your debt repayment strategy.”

Imara says most business people are aware of the deductibility of interest repayments when a geared asset generates income, but many middle class families are unaware of these possibilities.

“The traditional focus on long-term capital appreciation creates the blind-spot,” notes Lara Warburton. “Typically, a hard-working family outgrow their original home and move into a new, bigger home. They keep the first home and rent it out.

“They pay off the old home at a faster pace because the remaining bond is usually lower and their sole investment objective is capital appreciation as house values rise over time. However, it may pay them to have a broader perspective on the opportunities created by ownership of two properties.

“A knowledgeable financial planner will point out these possibilities.”