Ask the experts – How to make Debt, Good

By Lungowe Chitah

It is important that before one acquires debt (whether as a business or in your personal capacity), you consider the need for it, your affordability and lastly timing. Having given consideration to these factors and still deciding to embark on the borrowing journey, it is important to know how to make the money work for you.

There are good loans and bad loans

Need: Getting a loan to buy chickens is an example of a bad loan. It also shows lack of planning. There are people going around selling chickens at K40 cash and K45 nkongole (That K5 you pay on-top is 12.50% interest per month) That amounts to 150% per annum. A loan should be gotten to purchase Assets. Assets are items like accumulate in value. A loan should not be gotten in order to pay for your expenses. A house is an example of an Asset. It appreciates in value and can be put for rent (making you money) or reduce your expenditure by saving you rent.

Affordability: Can you afford the loan you are getting? In other words, will your lifestyle have to change drastically to finance those chickens you ate 6 months ago but you are still paying for? A loan should be paid back using funds you have in excess. An example is getting a salary increment which can be channeled towards paying a loan which purchases an asset to increase your wealth.

Timing: A business loan gotten in December when you know most businesses are closed and thus business will be slow is not the best decision time wise.

What do Banks and Financial Institutions Assess? The below 5C’s are credit criteria used

a) Character

Also known as your credit history, the first C refers to the borrower’s reputation and track record on repaying other debts. This information is easily available from the Credit Reference Bureau. Your credit report contains detailed information about how much you have borrowed in the past and whether these loans were repaid on time. These reports also contain information on collection accounts, judgments, liens and bankruptcies, and they retain most information for five to ten years.

b) Capacity

Capacity measures a borrower’s ability to pay the loan and compares income against recurring expenditure.

c) Capital

Lenders also consider any capital the borrower puts toward a potential investment (it is important to remember the NEED factor here). Any credible financial institution has the right and obligation to ask what you need the money for. A large contribution by the borrower decreases the chance of default. For example, borrowers who have a down payment for a home typically find it easier to get a mortgage/home loan.

d) Collateral

Is the loan secured or not? Collateral helps the borrower secure the loan which in turn gives the lender some assurance that if the borrower defaults, the lender can repossess the collateral and in turn dispose of it. It is important to remember that it is not the aim of any financial institution to dispose of assets and therefore this is a fall back option, however having collateral also leads to paying less interest due to a decrease in risk. In other words, the riskier the deal, the most interest you pay.

e) Conditions

The conditions of the loan, such as its interest rate and amount of principal, influence the lender’s desire to finance the borrower. Conditions refer to how a borrower intends to use the money. For example, if a borrower applies for a car loan or a home improvement loan, a lender may be more likely to approve those loans because of their specific purpose.

What Credit Options are available to you?

a) Secured Loan

Depending on the source of the loan (i.e. Bank, micro-finance institution or even a building society) this line of credit takes time to access. A bank takes the longest time to approval but also comes with the lowest interest rate. A micro finance institution is much faster in its decision making but this comes at a cost (higher interest).  A secured loan is less risky as there is a component of security which makes this option a “good debt” for the bank.

b) Unsecured Loan

Unsecured loans include personal loans, overdrafts and credit cards. These are the easiest loans to access. From a financial institutions point of view, these are also riskier as there is no collateral provided and therefor a higher interest rate meaning they are relatively an expensive option for debt.

How to repay your debt

Pay off your debt sooner than is required It is important to note that the repayment amount provided by your financial institution is a mere minimum of what you should pay back. By increasing your monthly installments, you are able to pay your loan off sooner as it reduces the amount of interest payable. Any lump sum you are able to pay towards clearing your debt puts your closer to clearing this liability.

Remember to shop around

Visit various companies and compare interest rates. There are a number of hidden costs and unknown clauses we tend to ignore when getting the loan. These have come back to haunt a lot of borrowers. To protect yourself, get a full understanding of the rules and conditions inherent. Ask what interest rate you are charged. Is this a floating or fixed interest rate? What happens if you default? What are the documentation, administration, front load fees? What insurance are you paying for? What does that insurance cover? Understand what you are signing.

Create (and live within) a budget

A budget is one of the most overlooked aspects in life. We have been taught to prepare company financial statements and prepare budgets. How many of us do this on a personal level? If you really want to pay down debt faster, you’ll need to prepare for this by creating a budget and sticking to it. Cur out all unnecessary expenditure and focus on paying your loans off as soon as possible.

After repayment of Debt, invest do not just save

Once your debt has been repaid, put the same installment towards investing. Savings are great in the short term but earn minimal interest. Investing on the other hand seeks to create wealth over the long term. Your lifestyle will already be adjusted down to cater for your loan payments so there is no need to adjust your lifestyle further. Remember tomorrow always comes and prepare for that eventuality.

Altus Capital, Contact us on 0211 22 7 228 (