There’s a lot to be said about so-called Millennials, but recent data suggests they’re not good at managing credit.
Described as entrepreneurial, health-conscious and tech-savvy, Millennials (consumers aged between 18 and 35) also seem to be hungry for high-value property and are showing signs of struggling to pay their mortgage bonds, according to credit bureau Compuscan.
The number of mortgages with a value of R3 million or more granted to Millennial buyers increased by 21.8-percent between the second and third quarters of last year. In the same period, there was a steep increase in the number of “adverse enforcements” against home loans held by Millennials. An adverse enforcement is when an account has been handed over to a debt collector or when a credit provider takes legal action against a debtor.
According to Compuscan, of all credit-active consumers, Millennials had the most notable increase in the percentage of mortgages with adverse enforcements. “We suspect that these consumers bit off more than they could chew and were thus struggling to keep up with their repayments,” Jacobus Eksteen, a senior data analyst at Compuscan, says. Either Millennials had borrowed up to the limit of what they could afford, or they had succumbed to the increase in the cost of living, he says.
Compuscan’s data also shows a significant quarter-on-quarter increase (18.65 percent) in the number of telecommunications accounts up to the value of R500 held by consumers in this age group. This was the highest increase in this type of account listed as open (active) at the bureau among all age categories, which suggests that more young consumers have gained access to credit. It is likely that a number of these consumers did so with the aim of building a credit record so they could take on other forms of credit, such as mortgages, Eksteen says.
There was a six-percent increase in the uptake in vehicle finance among Millennials quarter on quarter.
Buying a new car
The appeal of a new car, particularly a high-end car, can be great for a graduate who is starting out and earning well. But if you don’t fully appreciate the cost of credit, an expensive new car can set you back years.
Actuary Ryan Campbell-Harris of Simeka Consultants and Actuaries provides the following example of Millennials Tom and Jack, who earn the same salary and can both afford to finance a car that costs R500 000.
Tom wants to reward himself with an expensive new car right away and decides to finance it over six years. Jack is more disciplined. He decides to finance a car that costs R200 000, while saving towards his dream car. So he invests the difference between the monthly payment needed to finance a car that costs R500 000 and the monthly payment on his R200 000 car.
In other words, both men are paying the same amount (R9 270) each month over the six-year period. However, Jack invests a portion of the amount, whereas Tom pays the full amount to the vehicle-finance company.
After six years, both men trade in their cars at a 40-percent residual value and use the proceeds as a deposit to buy the same type of expensive car, which has escalated to R689 400 (assuming an inflation rate of 5.5 percent).
Tom finances the balance of the purchase price with a finance company. Jack uses the net proceeds from his investment, which has grown to R519 900 (assuming an after-inflation annual return of four percent), to boost his deposit on the car. Tom, therefore, has to finance a new loan of R489 400 (R689 400 – R200 000 [40 percent of R500 000]) over the next six years, whereas Jack has to finance a loan of only R89 500 (R689 400 – R80 000 [40 percent of R200 000] – R519 900).
Campbell-Harris’s example shows how interest can work for you or against you.
You want to earn interest on an investment rather than pay interest on a debt. For six years, while paying interest on his car debt, Jack invested R5 562 a month to earn interest.
Let’s assume that Jack again saves and invests the difference between Tom’s loan repayment and his own repayment.
After six years, the men trade in their cars, at a 40-percent residual value, and use the proceeds as a deposit on a new expensive car. The price of the car has grown by the assumed inflation rate of 5.5 percent to R950 600.
Tom once again finances the balance of the purchase price with a finance company, whereas Jack uses the net proceeds from his investment, which has grown to R692 100 (assuming an after-inflation return of four percent a year), to reduce the payment required for the car.
However, this time the resi-dual value of his car, R275 800 (R689 400 x 40 percent) and the proceeds from his investment are more than sufficient to buy the car without having to finance it. Jack has a balance of R17 300 ([R275 800 + R692 100] – R950 600), which he invests. Jack once again invests an amount every month that is equal to the amount that Tom has to pay each month for the new financed vehicle.
Car and a return
After financing their third cars, both men are driving the same type of car. However, Jack has the benefit of enjoying both the car and a net investment of R1 192 500. After 18 years, when his first child starts university, Jack has R1.2 million in the bank, which is more than enough to buy the next car using cash, or to cover the cost of his child’s tertiary education.
Tom and Jack paid the same amount every month. The only difference is that during the first financing period Jack bought a cheaper car and used the balance to start saving for his dream car.
The cost of financing the additional R300 000 for the expensive car, rather than purchasing down, cost Tom about R1.2 million, 18 years later in his career.
So the next time you find yourself trying to work out how much credit you can afford, think of Tom and Jack, and consider that you may be asking yourself the wrong question. Instead, ask yourself whether you are prepared to spend money today that you haven’t yet earned, because that’s what you’re doing when you spend on credit. Also consider how you could put that money to work for you, rather than against you.