Managing personal debt

One of the main elements of financial inclusion is access to credit. CBN has set a target for the country and the banks and non-bank financial institutions are running with the vision. People are being offered personal loans; borrowing has been made easy. Perhaps to them, it is a sign of financial advancement, after all their friends and family in so-called advanced countries have a plethora of debts; everything is bought on credit, electronics, clothes, entertainment, even food. But debt can be devastating if not properly managed.  The elixir of not having to wait for what you want but getting everything instantly can be addictive. Some people justify borrowing by saying – even rich people borrow, the richest people and the best companies in the world have the biggest debts. The major difference here is that they borrow for production; the money they borrow is invested and it yields returns from which repayment of both principal and interest is made and there are still some profits left for the borrower. This is not the case with consumer loans. When we borrow for consumption, we have to dig into our income; money that could have been used for other purposes is diverted to repay both the principal and the interest. Loans for productive uses can provide leverage that enables the borrower to achieve financial goals faster but borrowing for consumption slows down the attainment of financial goals. If we study our friends abroad who depend on consumer loans, we see that the live from pay cheque to pay cheque and are not able to achieve financial freedom.

Sometimes we could have emergencies and may have to take personal loans. When we finish repayment, we should proactively plan for future emergencies. Obtain adequate health, vehicle and home insurance. Establish an emergency fund and save in there regularly. This way, we are better prepared for emergencies and even if we have to borrow, the loan amount would be much smaller.

Consumer loans are very expensive, some as high as 5% per month on the outstanding balance. So, if you have to take one, ensure it is for the shortest tenure possible so you can reduce the amount of interest paid.  For instance, for a loan of N120,000 at 5% per month, repaid N30,000 monthly over 4 months, you pay interest of about N15,000. If you choose to repay N10,000 over 12 months for the same loan of N120,000, you pay interest of about N39,000. So, opt for short tenures and renegotiate existing loan tenures. Some lenders demand a penalty for early repayment, pay the penalty, it would still better than having a long-term debt. Credit cards can be managed in such a way as to eliminate the interest element; this is done by paying the full amount spent within one payment cycle. However, saving for expensive consumer goods excludes the interest component completely – choose that option.

If you have consumer loans, it is better to use our resources to pay them off early than to put large sums of money into savings or investment accounts. Imagine putting money in treasury bills for 7% per annum whilst maintaining a debt at 60% per annum. This anomaly is obvious.

Avoid taking too many loans. Monthly repayments should not exceed one-third of your monthly take home, otherwise important life sustaining expenses would suffer, and you would be tempted to take additional credit to relieve the hardship. This creates a debt trap and makes prompt repayment nearly impossible.

All lenders are required by law to send details of their lending (good or bad) portfolios to the credit bureaux. If you do not service a loan as and when due, the report is filed and remains in your record. This can work against you if you want to take more important debt like business loans or home mortgages or even get a post-paid line from a telecoms operator. So, let’s ensure we take only the loans we can comfortably repay with one-third of our monthly take home.

Prompt repayment can be facilitated with the use of bank standing orders. Most lenders would demand this or collect post-dated cheques from the borrower. However, some lenders still rely on the borrower to facilitate repayment, so help yourself by setting up standing orders with your bank and ensuring the account is funded on payment date. If you are a salary earner, let repayment date coincide with salary date. A good personal finance management software will help you manage this effectively.

The counsel from all personal finance advisors is that we avoid consumer debt altogether. Use debt productively, not consumptively. Happy investing.