The cost of borrowed money and the advantage of settling debt early

The dark side of the sun
November 8, 2017
Have you considered the cost of estate duty?
November 8, 2017

Among the top reasons South Africans borrow money are to purchase houses, start businesses, fund kids’ education and cover health care costs. While credit can be a useful tool in assisting you to achieve your goals, it is important to understand that credit never comes without costs.

The cost of credit or borrowed money is made up of three main components. These are interest, fees and how one chooses to pay back the money. 

Interest

Interest is the percentage of a loan amount which credit providers charge borrowers for the privilege of using their money. 

Fees

 Service Fee: A fee charged on a monthly or annual basis to maintain a credit agreement. 

Initiation Fee: A once-off fee charged when a consumer enters into an agreement. 

Credit Insurance: This is a life insurance policy taken out by a borrower to cover the debt in the event of death, disability or unemployment. 

Default Charges: If you default the following fees may be charged:

  • Administration default charges
  • Collection Cost- this is the amount spent on collecting overdue amounts. 

Other Charges: Additional charges may apply on a credit agreement and these should be discussed carefully with your credit provider.

How one chooses to pay back the money

Capitec Bank recently released three scenarios which show what the total cost would be to pay back a loan of R 100,000, based on the method one uses to pay back the money.

The following were the assumptions used:

  • Loan Amount: R 100 000
  • Term of Loan: 5 Years
  • Interest Rate: 21%

In the first scenario, settling the loan on time over the five-year term would incur a total cost of credit of R 192,376 (capital, interest and costs). In the second scenario, settling the loan after the agreed term would incur a much higher total cost of credit equal to R 204,270. In the third and final scenario, settling the loan before the end of the agreed term would result in a total cost of credit of R174,579, which is significantly lower than the other two scenarios.

In conclusion, it is clear from the above that there is a significant advantage in settling debt early. As there are ways and means of influencing the total amount to be repaid when one borrows, these should be thoroughly investigated and borrowers should try to do everything possible to settle debt as early as they can.

This article is a general information sheet and should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted. (E&OE)

Varushka Chetty
Intern
FPM Risk and Wealth Management
varushka@fpm.co.za
011 778 9300

SRA
SRA