What to know before you borrow
Knowing the difference between a short-term loan and an unsecured loan can mean the difference between paying interest of 60 percent or interest of 31 percent a year.
A short-term loan (essentially a microloan) is a type of unsecured loan but it has a specific definition under the National Credit Act (NCA), which sets the maximum interest rates and fees that you can be charged in respect of any credit agreement entered into after June 1, 2007. (“Maximum interest rates”: go to link.)
Yet five years since the Act came into full effect, consumers are still not yet fully informed about the various credit agreements and the maximum interest rates that apply to each. Being uninformed renders you vulnerable, especially when you need credit urgently.
If you’re cash-strapped and you don’t have any savings, the most cost-effective credit is usually your home loan. Many consumers are paying an interest rate of prime (currently 8.5 percent) 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 10.5 percent.
Remember, that to dip into your bond, you must have an access facility and you can borrow only as much as you have paid back to the bank. Most importantly, when you take money out of your home loan account, you must pay it back as fast as possible. Otherwise you end up stretching your debt over the term of your bond, which would prove very expensive.
If you don’t have a home loan, you may have no choice but to go for an unsecured loan. Depending on how much credit you need, this leaves you with two options:
1. A microloan, which the NCA defines as “a short-term credit transaction”, is any amount less than R8 000 and payable over not more than six months.
2. An unsecured loan – also known as a personal loan – can be for any sum of money up to certain maximum amounts. Banks and credit providers are offering unsecured loans of up to R230 000, which you can pay back over periods of up to seven years. These loans start from as little as R250 at Absa, R500 at Standard Bank and R1 000 at First National Bank (FNB) and Nedbank. (“Unsecured personal loans up for grabs”: go to link.)
An unsecured loan is one where the loan is not secured by any property or surety. Although you remain personally liable and your assets can be sold if you fail to make payment, you don’t need assets to obtain the loan. For this reason, interest charged on unsecured credit is typically higher than the interest charged on a secured loan, such as a home loan or vehicle finance.
With a secured loan, you normally “secure” the loan with an asset – be it your house or car – which can be sold if you suddenly aren’t able to repay the loan. For this reason, you pose less of a risk to the credit provider and therefore more favourable interest rates apply than the rates offered on unsecured loans.
Unsecured loans are big business. The total value of unsecured loans granted in 2008 was R30.8 billion; last year it was R83.3 billion, which translates into annual growth of 40 percent.
Although there has been a drop in unsecured lending over the first quarter of this year, banks and credit providers are still actively marketing unsecured loans, and consumers are hungry for them (see “Households are hungry for credit”, below).
Interest on unsecured loans
So, what interest can you expect to be charged for an unsecured loan?
It all depends on how a credit provider or bank scores you in terms of what you can afford and your credit history.
Arrie Rautenbach, the head of retail markets at Absa, says credit is assessed on an individual basis, considering the individual’s affordability and the requirements set out in the NCA. “The bank uses 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.” Rautenbach says “low-risk” customers can get a rate of prime (currently 8.50 percent) on a personal loan.
All of the loans in the table (“Unsecured personal loans up for grabs”: go to link) 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. So whether interest rates move up or down, you pay according to the rate you agreed to when you entered into the credit agreement.
In terms of the NCA, a credit provider may not unilaterally increase your interest rate unless your credit agreement provides for a variable rate of interest.
While the interest rate you are charged will be based on the credit provider’s assessment of you, you can’t be charged more than the maximum rates prescribed in the NCA ((“Maximum interest rates”: go to link). And for an unsecured loan it is the repurchase rate multiplied by 2.2 plus 20 percent.
So, assuming you qualify for a loan of R180 000 and are granted it today, the most you can be charged in interest is 31 percent (5 x 2.2 + 20 = 31). On a loan of R180 000, at the highest interest rate, your repayments would be about R5 270 a month for the full seven years. By the end of the term you will have paid the credit provider no less than R440 000 in capital repayments, interest and fees.
Remember that before you enter into a credit agreement with a credit provider, you are entitled to a pre-agreement disclosure statement and quotation in paper or electronic form. The quote must disclose the principal debt, interest rate, other credit costs, the total cost of the proposed agreement and the payment schedule.
Interest on microloans
Microloans fall into the category of what the NCA defines as “a short-term credit transaction” – one where the amount does not exceed R8 000 and is payable within a maximum of six months. For this type of loan you can be charged interest of no more than five percent a month or 30 percent over six months – or 60 percent a year, if you continually borrow against the loan.
The Act stipulates that interest rates on these particular loans must be disclosed as a monthly interest rate, but not whether the interest rate is nominal or effective. It does however state that “the interest rate must not exceed the maximum prescribed interest rate applicable to the category of credit agreement concerned” and provides formulas for how interest must be calculated.
Some credit providers offering short-term loans extend to you additional credit (up to your original loan amount) as soon as you have made your first or second instalment. In doing so, they are effectively giving you what is known as revolving credit – much like you have on a credit card, which allows you to keep borrowing up to a limit – except with this short-term loan credit you can wind up paying interest of 60 percent a year, or more if the interest is compounded.
Stephen Logan, an attorney and co-author of The Credit Guide, says despite the ambitions of the NCA, the most financially vulnerable consumers still pay the most for credit, because usually the only credit they can access is “these extremely expensive short-term loans”.
“The National Credit Regulator, together with the Department of Trade and Industry, has had five years since the NCA came into effect to reduce these rates, but there is still no sign of their coming to the rescue of these consumers,” he says.
Given the maximum prescribed interest rates, short-term credit agreements are the least attractive – or most expensive of all – for the consumer who qualifies for all types of credit and is able to choose between a microloan, personal loan and credit facility.
If the consumer who takes out a short-term loan qualifies for an unsecured personal loan, it would be more cost-effective to go that route – 31 percent versus 60 percent. And if the same consumer used their credit card, it could be better still because the maximum interest that you can be charged on a credit facility is 21 percent at the current repo rate.
Consumers hungry for credit
John Loos, household and property sector strategist at First National Bank (FNB), says South African households have a growing appetite for borrowing, notably in the area of non-mortgage credit, which he says is not helping reduce indebtedness.
Loos says that very low interest rates have the ability to mask much of the household sector’s “financial fragility”, and that much work remains to be done before the country’s household sector can be deemed to be financially healthy.
“The ultimate rise in interest rates, not expected just yet but sure to ultimately happen, is invariably where the financially weak will be found out.”
Loos says that for now, “the tide is still in”, referencing financial guru Warren Buffett, who says that when the tide goes out we can see who has been swimming naked.
“But a big part of this is due to very low interest rates as opposed to genuine improvements in underlying financial strength, and high indebtedness levels persist,” Loos says.
Interest rates are at a 38-year low, making it relatively cheap to borrow.
The ‘in duplum’ rule
The in duplum rule is a common law rule which limits the interest that a creditor may charge on an account that is in arrears. The common law in duplum rule holds that “interest stops running when the unpaid interest equals the outstanding capital”.
The National Credit Act enacts the in duplum rule into legislation and goes futher. It says that not only interest stops running when the unpaid interest equals the outstanding capital, but that all other costs – namely initiation fees, service fees, credit insurance, default administration charges and collection costs – should be included, together with the interest in an aggregate amount which should not exceed the unpaid balance of the principal debt at the time of default.
Annemarie Friedman, senior legal adviser at the National Credit Regulator, says an important qualification applies: “It is only amounts which accrue while the consumer is in default which are taken into account.”
Other charges on your loan
In addition to interest, a credit provider may also charge you an initiation fee when you take out a loan. In terms of the NCA, the initiation fee on both unsecured loans and short-term loans is R150 per credit agreement, plus 10 percent of the amount of the agreement in excess of R1000, but may never exceed R1 000.
You may also be charged a monthly service fee of no more than R50 (before VAT) and you may have to take out credit life insurance, which will incur a monthly premium.
A credit provider can insist that you take out credit insurance and maintain it for the duration of the agreement, but the credit provider can’t make you take out insurance that it is offering you. Whatever policy you take out must cover your total liability and no more. So, as the amount owing reduces, so too must your credit insurance premium.
Stephen Logan, an attorney and co-author of The Credit Guide, says credit insurance removes any real risk of default for the credit provider, but this [reduction in risk] does not usually result in a significant reduction in interest or fees charged. “Credit providers are having their cake and eating it at your expense,” he says.