D5 - The Shocking Cost of Our Bad Debt

We're going to look at the actual cost of our "bad debt" and how it is a lot more than what we thought.

The cumulative costs of our bad debt are scary

Is a Personal Monthly Budget Really Necessary?

We don't need to be convinced that a personal financial budget is necessary - we already believe it is! In fact, we have been using a budget it for years now . "So why are you still struggling to get out of debt?" - I hear you say. Well, that's what we're here to find out, so stay tuned! Neither are we going to try and convince you that a personal budget is necessary. We'll write about it soon and let you decide for yourself.

The Goal of This Post

In this post, our goal is to determine the true cost of our "bad" debt and list it as a monthly expense. Once we do that, we will be able to figure out how much extra we have each month to pump into the "principal/capital" portion of our debt, thereby eliminating it as quickly as we possibly can.

🤓 Fun Fact

The minimum credit card monthly payment (that 3 to 5% amount the banks wants us to pay every month) is not an actual expense. From a technical accounting perspective, only the interest charged on our outstanding balance, along with the account and debt protection fees, are treated as expenses. The remaining portion of our minimum monthly credit card payment goes toward reducing your debt (the principal), and is not considered an expense, but rather a repayment of liability.

Calculating The Actual Cost Of Our Debt

What follows is a snapshot of the cost of our debt.

A spreadsheet showing what the actual cost of our debt is - the monthly expense

If you like, you can download the spreadsheet here - called the COST OF DEBT CALCULATION. It's a simple spreadsheet - with instructions in the first tab - where you can manually enter all the costs related to your own "bad" debt (credit cards, personal loans, overdrafts), and it will tally up and give you that figure, as highlighted in yellow above in the bottom right cell.

From the above picture/spreadsheet, you can see that the total monthly fees (that yellow highlighted cell) directly related to having all this bad debt - the cost of our debt - is currently about R8 617 per month, and not the total of the interest column which is R6 761. At the moment, the average annual interest rate of our debt is 17.04%. If we start paying off our highest interest rate debt first, logic tells us that the average interest rate percentage will start reducing. And not just that, paying of the highest rate first will bring down that interest rate average the fastest. I mean, that has to be our strategy going forward - tackling the debt with the highest interest rate first so that in the long run we pay less interest on our total debt.

The Shocker

The shocker is that if you add all the other fees (last column) like debt protection (insurance) fees, card fees, and account fees, the real cost of the debt - expressed as an annual interest rate - is closer to 21.73%. That's almost 5% more than the average interest percentage.

Conclusion

Don't be fooled by thinking that your the annual interest rate charged on your debt is the actual cost of your debt. The "wool" may just be pulled over your eyes.

We can also conclude by saying that having this kind of debt, truly is expensive.

What's Next

Now that we have the actual monthly cost of our debt (i.e. R8 617), it's time to put that as a line item on our Personal Monthly Budget in our expense column. Then, after adding up all the expenses and subtracting that from our combined income, we should get the true amount of our SURPLUS/DEFICIT. But just before we do that, we want to share One Tiny Change That's Saving Us Thousands.

Until next time, take (financial) care!

Ensure to check out our Disclaimers & Disclosures section.