In less than a year, South African banks have dropped their prime lending rate from 15.5% to 10.5%. Under normal circumstances, one could expect some exuberance among consumers, but not this time round. Business confidence is low and consumers have witnessed retrenchments, property and equity markets losing much of the value that they’ve built up over the past years, and credit becoming scarce almost overnight.

Businesses would love you to channel the extra money left in your pocket after the bond rate cuts towards their cash registers, but should you not rather channel it towards your own bond repayments? Conventional wisdom screams ‘yes’ to the latter. And if you use our Killing your bond calculator, you may be pleasantly surprised at how big a difference even an extra R1 000 per month could make to your remaining bond term. If, for example, you still owe R500 000 on your bond and need to pay the bank R5 400 every month, depositing an extra R1 000 with every payment should decrease your repayment term by six years.

But settling home loan debt first is not necessarily the right answer for everyone. Running into cash flow problems is the cause of many foolish financial decisions, like selling fixed assets at the worst time in the market or applying for personal loans at much higher interest rates than the average home loan rate. Therefore first set up your own emergency fund – a high interest earning money market account containing about three times your monthly cost of living – for those times when the going may get tough. Owners of business start-ups or businesses still struggling with their cash flow, may want to build up an even larger cash buffer.

There are also ways of spending your extra money that could provide you with a much higher return than the interest on your bond. Enrolling for a course that increases your annual earning potential is one example of such a high-return investment. It seems like the average MBA graduate, for example, can expect his or her tuition fees back in the first year after studying – in the form of a much higher salary.

But these higher-yield investments seldom guarantee their returns, while you can be pretty certain that putting extra money into your bond will decrease your repayment term and will have the same effect on your pocket as earning interest at your bond rate. Without having to pay tax on it.

What % of your gross income goes into your bond?
	more than 25%
	between 12 and 25%
	less than 12%
	I have no bond.
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You’ve got some spare cash. It could be a lump sum windfall or you may find that you consistently have some money left at the end of every month. You could invest it, but your outstanding debt is bugging you.

Should you settle your debt first?

If I was working for a big financial institution, telling you anything other than ‘Yes’ would probably get me fired – or reprimanded at the least. It’s regarded as irresponsible to encourage people to borrow to invest, which is effectively what you’re doing if you’re investing while you still have debt. But I believe the answer is not that simple and there are a few issues at stake, such as:

1. Return on investment (ROI)

What is your borrowing rate? If you owe money on your credit card at 23% interest, settling your debt would have the same effect as an investment with an ROI of 23%. (Think of it this way: If you owe R10 000, you would have needed to pay R 2 300 interest on that over the next year. By ‘investing’ R10 000 in your credit card debt, you are left with R2 300 extra in your pocket over the next year – an ROI of 23%).

Do you know of any investments that could beat your borrowing rate? According to Triumph of the Optimists, equity returned about 7% more than inflation, on average, over the past century. This makes it the best-performing asset classes over the long term. With inflation hovering just above 10% at the moment, settling your credit card (or other expensive) debt first is a no-brainer. But what about a home loan with a borrowing rate of 14%? Surely, you can find an investment with a higher ROI, you may think. But are you comparing apples with apples? With the other investment, how certain are you of your ROI?

2. Uncertainty (a.k.a. ‘risk’)

When you settle or reduce your debt, your return is guaranteed at the rate of borrowing. On the other hand, if you choose to invest in property or the stock market, there are many uncertainties. Are we heading for a long-term recession like the world’s 2nd largest economy, Japan, which could suppress the stock market for longer than you expected? Will you always have tenants providing you with steady income on your property investment? What is the next version of the current sub-prime crisis and how will it impact on your investment?

3. Cash flow

Do you have enough emergency cash in a money market unit trust or another easily accessible and stable investment product? If not, you may want to rather keep your spare cash for any unforeseen events that could really hurt you financially. Do you perhaps have a home loan account that allows you to withdraw any extra payments within 24 hours? Transferring your extra cash to this account could provide a really good, tax-free return, with the benefits of an emergency fund.

4. Tax

If you are considering investing your spare cash, how much tax will you pay on your return? Any interest and rental income over your annual allowance of R19 000 will be taxed at your marginal tax rate (the rate of your tax bracket as determined by SARS). In contrast, your return on your debt settlement is tax-free.

Have you looked at the flip-side of our tax system? Are there any investments that could provide you with some tax-relief? In other words, the more money you invest, the less tax you pay. Retirement annuities (RAs) immediately jump to mind. Liberty, for example, launched a quirky, but memorable ‘Love the Taxman’ campaign earlier this year to remind you that you can contribute 15% of your non-pension funding income to an RA and deduct those contributions from your taxable income when completing your tax return. If you’re in the 40% tax bracket, you could see an ROI of 40% due to the tax-rebate alone, and that’s before adding the growth of your RA investment over the year. I don’t know for how much longer this opportunity will be available, though. Policymakers are working on new legislation that will limit the RA contributions on which you can claim tax-relief, as there have been complaints that current legislation favours high income earners.

5. Time

Debt can keep you in a job you don’t really enjoy or make you postpone those full-time studies or travelling which you’ve been dying to undertake for so long. The sooner your debt is under control, the sooner your time is your own again.

6. Emotional benefits

Let’s face it, being debt-free can be pretty euphoric. While encouraging you to look at the hard figures like ROI and tax benefits when weighing your options, sometimes getting those shackles off is about more than just the money.