Sounds crazy, but it happens. Here’s how. According to the National Credit Regulator, there has been a steady and substantial increase in unsecured lending. Unsecured loans are used for many things, from putting food on the table when things are tight, to buying a car.
There are formal loans and informal loans. In this article we will only be looking at formal loans offered by registered credit providers. Informal loans (from loan sharks, etc) are a major problem and should be avoided. Their interest rates are financially crippling and they are not governed by the National Credit Act (NCA), leaving little recourse for abused clients.
Unsecured lending refers to loans without security, which is used to recover the debt in the event of non-payment.
But, but the NCA protects me…
The NCA has remedied many of the problems that existed in the credit provision market, and has provided recourse for people who are unable to repay their debts. However, a borrower must still be savvy to ensure they are borrowing in the most efficient way. The NCA has set maximum interest rates chargeable for the various types of loans. Institutions offering unsecured loans tend to charge the maximum interest rate allowed, sometimes decreasing the rate for lenders who prove they are good payers over time.
Their secret weapon
The biggest issue with loans is the additional fees. The NCA allows credit providers to charge loan initiation fees of up to R1000 (+VAT) as well as monthly service fees of up to R50 (+VAT). The impact of these fees increases the smaller the loan is.
For example, someone who is having a tough month might borrow some money from a microlender to put food on the table until payday. A R1000 loan borrowed for 10 days, will cost R248.19. However, borrowing the money for the whole month will cost R286.54, a mere R38.35 extra. The reason is that most of the cost of the loan is made up of the initiation fee (R171) and the admin fee (R57). The interest on its own is only R58.54 (although that is still an interest rate of around 60% per annum). But what’s really interesting is that they are charging you interest on the initiation and admin fee as well! With small, short-term loans, the interest rate is almost irrelevant as the majority of the cost comes from the fees.[tip title=”TIP 1:”]If you believe to be a victim of overcharged interest rates on your loans, spot them in your credit report here.[/tip]
If you were to borrow R1000 for 10 days in this way, every month of the year. It would cost you R2,978.28 per year. So is it cheaper to borrow from a bank? Capitec charges the same interest rate and the same fees, but doesn’t charge a monthly admin fee if the loan is a month or less. So the cost of borrowing R1000 for a month is R230, a saving of R56.54 (which is basically the R57 initiation fee).
Sometimes a loan is needed for something more substantial. Examples would be car repairs, house renovations, etc. In this case the loan is for a larger amount over a longer period. The costs are again a large part of the repayment. For example, if we wanted to borrow R25 000 and pay it back over 2 years, the initiation fee would be R1140 (they charge you interest on this amount too) and every month there would be a R57 service fee. If you borrowed R25 000 without any fees included your monthly payment would only be about R1,416. So that means about R120 per month is just to service the fees. That’s R2904 over the life of the loan, nearly 12% of the amount you’ve borrowed.
Which means that while the interest rate is 31.4%, you’re actually paying about 50% interest on the money you borrow. The end result is that after 2 years you have paid back R36,899. And this is assuming there are no other fees. Some lenders require you to pay extra for life insurance as well. Let’s flip this on it’s head. If you saved R1,537 per month, how long would it take you to save up R25 000? It would take 17 months (and you would have a few hundred Rand extra too). So less than a year and a half and you would save yourself the R11,899.
This is a fundamental problem and why people are struggling under mountains of debt. If a family wants to upgrade their old TV to a nice new flatscreen TV. Instead of waiting and saving R1000 a month for 10 months to pay for the R10 000 TV, they take a loan for the money over a year and end up paying nearly R14 000 for the TV. When you’re paying nearly 1.5X the price of everything, then it does become difficult to make ends meet.
Here’s some advice for avoiding these well-laid traps:
- In the case of small, short term loans, it is advisable to look into alternatives, in order to avoid the steep fees.
- If you have a credit card, remember that you get a monthly interest free and there are no additional fees.
- If you have a bank account, check what the charges would be to have a small overdraft facility. If you have a house or car loan, see if you can access that cash. These may be much cheaper ways to access small amounts of credit.
In conclusion, when it comes to unsecured lending, the banks are charging the same rates and fees as the microlenders. It may be possible to get a better interest rate if you have a good credit history, but seeing as the fees make up a large proportion of the overall costs of borrowing, a small decrease in the interest rate won’t really have much impact.
Avoid borrowing whenever you can. Having no debt is the quickest way to improve your budget.