Rate cut provides both risk and opportunity…

The Monetary Policy committee reduced the repurchase rate by another 50 basis points at the last meeting today.

This rate cut provides some relief to the pressures on household disposable income, but could potentially be very dangerous for consumers when they do not consider the risks faced in the near future. The stimulus from the reduction in the prime lending rate from a high of over 15% have started to wear off, as the household sector has grown more and more used to the low interest rate environment.

Credit policies of banks and other lending institutions have been tightened as the South African consumer is still faced with the risks of retrenchment and reduction in discretionary income (commission/bonuses). Many small business owners have yet to see an increase in sales, which leads me to believe that there is still a great deal of financial pressure on the household sector, despite some positive statistics such as low inflation numbers and positive housed price growth.

Prime rate movement happens in cycles

Consumers should take the possibility of rising interest rates into account when structuring their debts. It is inevitable that interest rates will go up in the future, and poor planning of monthly expenditure could lead to a distressed situation very quickly. When rates go up in the near future, debt repayments could quickly exceed available disposable income and make it impossible to service monthly repayments.

Opportunity to reduce debt levels

The low interest rate environment could be used as an opportunity to reduce high levels of indebtedness. Consumers who are currently faced with high levels of indebtedness could use this short-term relief to fast track the repayment of some of their debt obligations. The additional cash flow freed up from lower monthly repayments could be used to pay back the most expensive (highest interest rate) debt first to have the most significant impact. This is usually credit and store cards, but should be assessed on an individual level and could greatly differ from person to person.

Risk of delaying tactics

Unfortunately, debt counselling has in some instances been used as a delay tactic to prevent the inevitable foreclosure of repossession of assets backing credit agreements. This was certainly not the intention of the NCR, and places the consumer in a worst position that he/she might have been in if the debt issues were addressed correctly.

Facing the inevitable

The latest reduction in interest rates could have a similar effect as consumers delay inevitable default on credit agreements. If a consumer is faced with financial pressure, it is much better addressing the problem immediately, and negotiating with the various credit providers before defaulting on a loan. Most reputable credit institutions have mechanisms in place to assist with debt restructuring and assistance in meeting obligations. Debt counsellors are professionally trained to assist in arranging the entire portfolio, and provide protection against credit collectors. In any scenario, addressing the problem directly gives an immediate better outcome than delaying or avoiding the inevitable.