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Four simple steps to manage your loans

Loan sharks are money lenders who charge extremely high rates of interest on loans offered. They are often considered as last resort options for borrowers who have ruined their credit rating (an estimate of the ability of a person to fulfill their financial commitments, based on previous dealings) and can no longer borrow from legal entities.

In the play “Merchant of Venice” by William Shakespeare, Shylock a loan shark is the play principal antagonist. He lends money to Antonio setting the security at a pound of Antonio’s flesh in case of default. Shylock demands the pound of flesh when Antonio defaulted on the loan. Shylock ends up losing the case after he is charged with attempted murder of a Christian.

Also Read: Why Kenya government borrowing is starving the local economy of funding

This ancient play depicts what most individuals go through when dealing with loan sharks. The high interest charged by loan sharks means that the borrower may default. The loan shark would then resort to uncouth methods to collect his due.

One may think that he/she may never fall prey of the loan shark in the same way a social drinker despises the drunkard lying in the gutter.  It’s always a matter of time before your small loans balloon into an unmanageable debt crisis that will leave you at the door step of a loan shark. Be sure he/she will be waiting to put the last nail in your financial coffin.

Enough with the vindication, let’s try to prevent the debt malady before it infects your healthy financial status. I will outline four things to consider before taking any kind of debt. Following these simple steps may help you have a sound financial plan of avoiding the dreaded Shylock.

  • Purpose of the loan

The purpose of taking out a loan is extremely crucial. This is the main determinant on what you are going to achieve with the borrowed money. Most individuals take loans for expenditure purposes rather than for investment purposes.

Take a simple example; assume two individuals take out loans worth one million shillings to buy cars. One buys the car for personal use while the other buys the car for taxi business. Let’s also assume that both individuals earn a net salary of Kenyan shillings 60,000 and will have a monthly repayment of 17,000 shillings on the loan. The taxi business generates net income of 20,000 monthly.

This may be their expected cash flow outcome.

 

INDIVIDUAL A B
Net salary 60,000 60,000
Loan repayment (17,000) (17,000)
Net Taxi income 20,000
Fuel Expenses (4,000)
Service & Insurance (5,000)
Net disposable income 63,000 34,000

Individual A has increased his/her net disposable income from 60,000 to 63,000 shillings while individual B has reduced his/ her income from 60,000 to 34,000 shillings. In essence, individual A has used the car as an asset while individual B has used it as a liability.

  • Your level of income

The level of income you get influences the amount of money you can borrow. Most of the lending institutions are willing to take extra risk and lend you more money than your paying capability. This means that the job to manage your borrowing has been left to you. Borrowing more than 20% of your income may result in you defaulting on the loan unless the money is used for investing purposes.

Most individual tend to spend more than they earn. This results in revolving loans and advances month in month out leaving no room for savings and continues to erode your wealth making you dependent on debt.

Evaluate your income and spending monthly before deciding to take a loan lest it becomes a great burden to you.

  • Interest rate on the loan

The interest rate charged on the loan also affects your ability to pay out the loan. You should be very keen on the interest charged for any given loan. Many individuals ignore the interest charged as long as they can get the loan.

For example, though mobile money has revolutionized banking, interest charged on mobile money loans are extremely high. For the M-shwari addicts, here is a breakdown for you. If you borrow 2,000 shillings, you will be expected to repay 2,150 shillings after a month. In interest terms, you will be paying 7.5% interest per month which is equivalent to 90% interest per year.

The amount makes you ignore the interest component but this will highly affect your ability to pay back the loan.

  • Duration of the loan

The duration of a loan is the time span you take to repay the loan. The duration of the loan affects the amount to be repaid. Duration is directly proportional to the amount paid at the end of the loan period. The longer the duration of the loan, the higher the amount you will pay and vice versa.

For example, a 2,000 shillings M-shwari loan at 7.5% interest for a month’s duration would have a repayment amount of 2,150 while the same loan for three months’ duration would have a repayment of 2,450.

The shorter the loan duration the lower the interest charged on the loan. The goal is to repay the borrowed amount as soon as possible to avoid incurring further interest charges.

Now that we are on the same page, I hope you will look into your financial management and avoid visiting the loan shark or better yet you can evolve into being the loan shark.

Also Read: PESA LINK: Kenya Banks’ Initiative to countering mobile money transfers

 

 

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Posted by Timothy II Aperit

True believer in numbers. Statistics never lie. Bsc Financial Engineering MBA Finance ACCA