Come the beginning of the year many people struggle to make ends meet and take out loans and other forms of credit to help cover expenses. But when it comes to taking on credit, it is important to do so responsibly.
Piet van der Walt, head of Sanlam Personal Loans, said: “There are times when taking out a loan may sometimes be your only option. For instance, when unplanned emergencies arise, a loan can be a lifesaver. The first thing you should ask yourself when considering to take out a loan is whether you really need whatever you are going to spend on it.”
Rekha Ramcharan, head of Absa Personal and Business Lending, noted: “It is important for you to fully understand the different types of credit products available to meet your needs – do you need short term, long term or recurring access to credit? Also, know what interest rates you are likely to pay and understand your financial obligations when taking out credit, before making your decision to apply.”
When applying for credit, Ramcharan emphasised that you should consider whether or not you can afford the credit you want to apply for. Look at your income and expenses, and see how much you can afford to comfortably repay every month.
According to debt counselling firm DebtBusters, it is important to consider what the loan will be used for. “Is it adding value i.e. an asset or it’s a once off to clear other debt or purchase groceries or luxury items.”
Interest rates and fees
There are two types of loans, either loan term or short term, wherein various products are available. Long term and short term loans have different maximum interest rates, so when taking out a loan it is important to look at what it is for and which type of loan would suit you best.
When it comes to taking out a loan, it is important to choose a reputable lender that offers personalised and competitive interest rates, highlighted van der Walt. “Often loan sharks and some micro-lenders tend to ask maximum interest rates over the short term. It is better to go to a reputable lender, who will do a comprehensive affordability assessment to ensure you don’t run the risk of defaulting.”
Shaun Rademeyer, CEO at BetterLife Home Loans, noted that short term loans are assessed on an individual basis taking into consideration affordability and the requirements set out by the National Credit Act (NCA).
“The banks use risk based pricing to determine the final price a customer is likely to pay on a loan. The final rate is therefore linked to the customer’s credit history and repayment track record. Low-risk consumers can get a rate of prime (currently 10.5%) on a personal loan. It’s important to remember that the most you can be charged in interest on a short-term loan is 31%. The one benefit of a short-term loan is that they are payable on a fixed-rate basis. In other words, the interest rate for which you qualify will be fixed for the term of the loan,” explained Rademeyer.
Ramcharan added: “Short term loans, as per NCA, can be charged at a maximum of 5% per month, unsecured credit transactions at a maximum of RR (repo rate) + 21% per year and unsecured credit facilities at RR + 14% per year. Longer term loans charge lower interest rates per year but are paid off over longer periods of time, with fees charged each month, which make them more costly in the long run.”
According to Ramcharan, there are no penalties for the early settlement of a loan, as per Section 126 of the NCA.
By contrast, Charlotte Vermaak, principal of Chas Everitt Nelson Mandela Bay, stated: “Should you want to pay off your mortgage debt before the term of the home loan has lapsed (in most instances 20 year term), the banks have the right to charge penalty interest charges to consumers who settle their home loans early.
“The penalty charge on early termination is equal to 90 days interest payable on the outstanding balance of the home loan. Alternatively interest will be charged on the difference between the notice period given and the 90 days required.
“These penalty charges can be quite costly e.g. assuming somebody owes the bank R1, 000, 000 at an interest rate of 10% - they could be paying close on R25, 000 in penalty fees if they cancel their home loan early without giving prior notice to the bank.”
Rademeyer highlighted that the most cost-effective form of credit is usually your home loan. Many consumers are paying an interest rate of prime (currently 10.5%) less one or even two percent on their home loans. Even if your bank is charging you prime plus two percent, this means you can access credit at an interest rate of 12.5%.
Vermaak noted that when it comes to mortgages you should try to get the lowest interest possible from the outset. “This is best achieved by shopping around for the best home loan deal, ideally through a Mortgage Originator for ease of convenience and at no charge. The Mortgage Originator will present your home loan application in the best possible light to several banks and then negotiate with the banks on your behalf to secure the best possible interest rate.”
However, Rademeyer stated: “You won’t be penalised if you pay of your home loan early, provided that you do not cancel the bond. The only time you will be liable for interest penalty is if you do not provide the financial institution with three months’ notice prior to cancelling the bond.”
Tips for responsible borrowing
Ramcharan and Vermaak offer the following tips to help people borrow responsibly:
- Get to grips with your income and expenses, to ensure that you are in a position to make the debt repayments.
- “Make sure that you understand the credit agreement fully before you sign it (ask all the questions you have) so that you understand your financial responsibilities,” said Ramcharan.
- If you encounter any difficulties with repaying the loan, Ramcharan advised being proactive in contacting the credit provider to make a payment arrangement.
- For home loans having a deposit can make a big difference to the interest rate charged, as well as the amount you need to lend. Vermaak also stressed the importance of considering the repayment term (20 or 30 years) and the financial impact that additional interest over 30 years could have.
- “Commit to making extra repayments whenever you can. Every time you have some extra cash (annual bonus, tax refund, etc.) pay some of that into your bond. You may miss it slightly over the short term, however, in the long term you can make significant savings on interest and the repayment term of your home loan. Paying an extra 10% of your repayment every month can reduce your home loan term by five years and save you a significant amount of interest. Even a once-off additional payment can make a big difference in the long term,” noted Vermaak.
- Know your credit rating. Ramcharan highlighted that you are entitled to one free credit check per year from the credit bureaus. This will help you have a better understanding of your credit status. For more information on understanding your credit score, click here.
Van der Walt added: “A loan should never be used for bad debt and things you can save for – such as splurging on an overseas holiday or your child’s wedding. You should preferably only take out a personal loan to meet financial ‘needs’, not ‘wants’. Things like home improvements – which will increase the value of your property and education – which is an investment in your or your children’s future are ‘good’ debt which usually justify taking out a loan.”