When to sell an Asset to pay a Debt?
Lechedzani Pitso | Monday September 29, 2014 09:15
We gauge our cultural wealth by how many cattle and goats we keep. However, we often have debts too – sometimes-big debts that cause us stress. Is it a wise choice that so many of us make to keep our assets whilst paying off our debts? Due to the emotional attachment, it’s a hard choice to consider selling items to pay down debts. Sometimes, selling them won’t completely clear any of the major debts - why should we consider it if it won’t solve the full problem?
The first step on the path to Financial Freedom
The answer is simple. Debts are expensive, and reduce your standard of living. If you can pay off even one debt, then you have started on the path to Financial Freedom. Let me show you how: Molefe* has several debts, but there’s one that he hasn’t been paying, so he’s been blacklisted with ITC for owing a debt of P12, 000. As you know, when you’re blacklisted you can only borrow from the very high-cost lenders – so Molefe has few options available. His assets are a vehicle and some cattle. If he could sell some cattle or his car to pay off his debt, he could then get his name cleared with ITC. Then he’ll be able to negotiate better loan terms, perhaps get a bridging loan or a consolidation loan, and start paying down his other debts. Molefe feels that his car is not in a great condition, so he thinks that he should keep it until he can afford to fix it, and then sell it. Unfortunately the value of cars can depreciate at 10% per year. So the longer he waits to sell it, the less it is worth. He also doesn’t have a plan to get the money to fix it. Molefe would be wise to sell it for whatever he can get for it, to pay off some or all of the black-listed debt. Debts attract interest, the interest is always more expensive than the potential earnings on the asset.
Prioritise your Debts
Once Molefe has cleared the blacklisted debt, he can then look at his other debts and decide the priority of each debt, drawing up a debt repayment plan.
Cost of Debts vs Income from Assets
We know that a true asset is one that grows in value or brings in an income. Things like vehicles are not really assets, unless they are vital for us to earn a living. We also know we are charged interest on every loan we take. This interest typically is higher than the interest we receive from our savings. The only time that it makes financial sense to use debt to buy an asset is if the value plus the income grows faster than the interest rate on the debt.Owning Your House – you save by not paying rent, and one day the resale value should be higher than what you paid for it.
The growth in value plus the saving on rent should exceed the mortgage interest. Investment Property – provided you can charge rent and have another source of income to pay the mortgage, this can work – but in today’s market, rental incomes are uncertain and you could get into trouble. Livestock – can be sold for extra income as they grow, and can be bred to increase the numbers of livestock we own, to make more profit at a later stage. However, they don’t make a monthly income to pay the interest on debt. Cars – The value of a new car falls 10% immediately after you buy it, and then its value depreciates every year by about 10%. If you’re also being charged 20% interest to buy the car, then you’re losing 30% of your finance cost per year. On top of that, they need to be insured, serviced and fuelled. Cars are not considered an asset unless you using them to bring in an income. Undeveloped Plots of Land – if you have the title deed or a leasehold, they may be considered an asset as they can be sold. They may increase in value over time, however, while they are undeveloped they don’t bring in any income and so are a risky asset to borrow against.
When Should you Sell An Asset?
If you have assets that are earning you less than the interest you are paying on the debt, then you are better off selling the asset and paying off the debt with the money. After all, you can always save and buy another asset at a later stage when you have paid off all your debts. By selling your asset and paying off your debts faster, you will soon have more money to live on and less stress in your life. Selling your car or some livestock makes sense if it means you feed your family and live a little easier.
What is Good Debt?
A home loan is considered ‘good debt’ because (a) owning your own house negates the expense of rent in your budget, and (b) when you live in the house long term you take care of it and increase its value as an asset. It is wise to keep your family home and not sell it, even if you are in debt. You can sometimes use your family home as security against a further mortgage loan that you can then use to pay off your other debts. However, beware of re-mortgaging if it is not absolutely necessary - it is going to cost you 20 years of accumulating interest. Only use this option as a last resort to restructure bad debts with severe interest rates.
Author: Lechedzani Pitso – Financial Wellness Trainer with S.C.I. Training (Pty) Ltd. © S.C.I. Training run financial wellness and debt counselling programmes in Botswana. For help and information contact them on 3180243 or 72309718 or leche@wellness.co.bw * Names in this article have been changed