How to avoid the festive season debt trap | Fin24
 
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How to avoid the festive season debt trap

Dec 22 2015 13:19
Carin Smith

Cape Town - Consumers thinking of taking out a loan to fund additional expenses over the festive season should weigh up the financial consequences carefully, cautioned Izwe Loans CEO Rayanne Jacobson.

The cheapest loan may not be the cheapest a few months down the line. That makes it critically important to opt for the right type of loan as your choice will have a significant effect on cash flow over the next few months, warned Jacobson.

“The first consideration is whether you will be in a good position to pay back the loan. If you are on a very tight budget, there may be a case for holding back on a holiday, expensive gifts or a lavish Christmas meal,” she said.

"While your intentions may be good, your family would rather have you in better financial health and should understand if you forego some of these expenses."

Three different loan options

Assuming a consumer needs R3 000 for festive season extras, there are three options: a payday loan (one month), a short-term loan (six months) or a medium-term loan (about eight months). Each has different implications and Jacobson warned that choosing the wrong one "could place you firmly on a debt treadmill".

Assuming a consumer earns a net salary of R10 000 a month and manages to save R1 000 each month as disposable income but can't afford additional festive season costs, using the R3 000 loan requirement example, and taking into account the average interest charged by numerous lenders as quoted on their websites, these three types of loans have very different financial implications.

Payday loan

If you go to a payday lender, you will need to repay R3 629 at the end of the first month. This probably means you will need to take out a further loan in month or two as well as in subsequent months, as your monthly disposable income of R1 000 will not cover the repayment.

Assuming you do need further loans to fill the gap, you may need six months to achieve a positive cash position and the cumulative cost of your loan could likely be in the region of more than R5 500.

Short-term loan

If you go to a short-term lender (usually a six-month loan), your monthly instalment will be about R740.16, which is far more manageable. And by month six, your total cost on the loan will be in the region of R4 441. Assuming you have R1 000 disposable income per month, you will be in a net cash position of around R260 from the get go.

Medium-term loan

If you go to a medium-term lender, and assuming an eight-month loan term, your monthly instalments will be a much more affordable R539.51 and you would have paid back just R4 316 after eight months.

What’s more, you will have a net cash position of around R460 each month after making your loan repayment. This is the best option in Jacobson's view, not only in terms of your total cost, but also in terms of having enough for other expenses over the loan period.

"Although the payday loan appears to be the cheapest, it is the most difficult to service and inevitably ends up being the most expensive, and pushes you onto the debt treadmill," she said.

Another thing to consider is that the more payday loans you take out, the less chance you may have to qualify for a longer-term loan.

“Credit providers look at a consumer’s credit record, among other things, in establishing a credit score. There is the possibility that regular and ongoing use of payday loans indicates that the consumer is in a debt trap and could, therefore, pose a greater risk,” explained Jacobson.  

"Both the six- and eight-month loan terms ensure you do not overcommit, and the payment terms will not leave you in a cash flow crunch. Your ability to have financial flexibility, responsibility and maturity is impaired when you go into payday lending, so check out all the options - and implications."

Disclaimer: Fin24 cannot be held liable for any investment decisions made based on the advice given by independent financial service providers. Under the ECT Act and to the fullest extent possible under the applicable law, Fin24 disclaims all responsibility or liability for any damages whatsoever resulting from the use of this site in any manner.


credit  |  money  |  debt
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