Understand how loans work to pay off faster and save money

Some of the furniture that belonged to National Cereals and Produce Board that had been collected for auctioning following a controversial default of over Sh. 500 million with a supplier. April 5, 2012.  Photo/BILLY MUTAI

In Summary

• Just like him, many account holders fall prey to the loans they first assumed as stepping stones to financial freedom.
• “If a customer is not clear-headed, he or she will end up living at the mercy of a lender’s claws.”
• Taking a loan often looks wise, especially where a borrower is servicing multiple debts and his or her bank has offered to pay them off.

By Kinuthia Mburu
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“The credit officers made it sound like a good debt,” begins cash-strapped Joshua Oduor.

“The prospect of getting a loan three times my savings thrilled me.

It brought out the greed in me and now I am paying through the nose.”

Well, that was five years ago when Mr Oduor took Sh600,000 personal loan after saving Sh16,000 per month for a year from his Sh25,000 salary.

Paying the loan has been a burden, he says. “I am paying more than I anticipated.

By the time I am done with it, I will have paid close to, if not more than half the amount I took. What’s the use of the loan in this case?”

Just like him, many account holders fall prey to the loans they first assumed as stepping stones to financial freedom.

Although lenders strike a friendly tone when wooing customers, their ruthlessness is legendary when claiming loan dues from defaulters.

“Lenders are our financial version of leopard in sheep’ skin,” says Mr Oduor with a tinge of bitterness.

“If a customer is not clear-headed, he or she will end up living at the mercy of a lender’s claws.”

WHEN IT ALL GOES WRONG

Sometimes, claiming defaults goes horribly wrong. James Simatei Kendagor attests to this.

In 2010, through its agents Igare Auctioneers, Faulu Kenya raided his farm seizing cattle worth Sh200,000 over a loan dispute involving the bank and his son.

Ironically, Mr Kendagor’s cattle were not listed as security for the Sh40,000 loan taken by his son nor were any of his other assets.

His son was guaranteed by a youth group. After a one-year court battle, Faulu was ordered to return the animals, which it declined instead filling an appeal at the High Court in Eldoret.

Later Faulu lost the case and was ordered to pay Mr Kendagor Sh200,000 for his cattle plus Sh209,205 as lost income, the cost of the suit and accrued interests.

Taking a loan often looks wise, especially where a borrower is servicing multiple debts and his or her bank has offered to pay them off.

This is the offer that Agnes Masimbo took hook, line, and sinker.

“I accumulated so many debts that my payslip was always in the red,” she says.

Her bank offered to pull her out of the mess. “My bank offered to lend me Sh950,000.

I agreed because the offer would leave me with one loan. I would also have some cash at the end of the month.”

REPAYMENT PERIOD

While the plan looked strategic, it was more beneficial to the bank than to her, says personal finance expert Nimrod Khaemba: “Her bank consolidated all her debts into one larger loan whose repayment was stretched over a longer period than the multiple loans she was servicing.”

The bank ensured that Ms Masimbo would pay the loan at a higher interest than she was paying her old debts.

Waceke Nduati-Omanga, who runs a personal financial management programme at Centonomy concurs: “You pay more interest when the repayment period is longer.

If you borrow Sh300,000 for three years at 15 per cent annual interest, you will pay approximately Sh10,400 per month and over the course of the loan, you will pay Sh75,000 in interest alone.

If you repay the same amount for five years, you’ll pay Sh7,100 monthly but Sh128,000 in interest.” The same amount for 10 years will accrue Sh280,000 interest with monthly repayments of Sh4,800, she told Money.

Evidently, the bait has always bordered on interest rates and the repayment period, which is being stretched to as far as 20 years by some institutions.

“Some lenders have been claiming to offer one per cent monthly interest on their loans. But borrowers must understand how much that will translate annually and how it could be affected should interest rates fluctuate,” says Mr Khaemba.

Adding that were all commercial institutions to show their monthly lending rates, the percentages would come around the same figure.

“The sound of one per cent may be music to a borrower’s ears in comparison to say 18 per cent.

But a customer should bear in mind the difference between monthly and annual interest rates.”

DEPRECIATING ASSETS

Alarmingly, says Ms Nduati-Omanga, many borrowers are lured into taking loans to buy assets.

“Some loans end up as a financial loss. But the credit officer will not tell you that you’re up to no good with a particular loan,” she says.

This is the loss that Elijah Mwenda is counting. Four years ago, he took Sh1 million loan to buy a car.

“All my friends had top-of-the range cars and I felt left out,” says Mr Mwenda, 35.

He signed a five-year repayment period, and this has cost him an arm and a leg.

“I’ll have paid close to Sh2 million when I finish,” he says, noting that he is mulling over selling his second-hand Subaru Forester to pay off his debt.

“The car has depreciated and he is in for a huge loss,” notes Ms Nduati-Omanga.

And therein comes the question: how can you pay your loan easily and fast?

According to Ms Nduati-Omanga, “put extra payments towards your loan and you will pay it down much faster,” she says.

“Doing so will help you reduce your overall interest costs.”

Apparently, many borrowers are not aware that they can repay their debts faster. “In loans, you fix it even if it is not broken,” says Mr Khaemba.

Adding: “Don’t wait to pay off huge amounts of money when you can make a quick exit early on.”