In the following week’s we aim to tackle some key financial topics such as: What is a loan? How does interest work and how does this effect you? Let’s start at the beginning by firstly explaining – WHAT IS A LOAN?
If you, as a consumer, borrow money from an accredited lender that makes you a debtor (borrower) and it makes the lending company your creditor. A loan can be broken down into the following components:
• Principal debt
This is the original amount of money that you have borrowed
• Interest Rate
Interest is the amount of money a consumer pays to borrow money. This is typically charged as an annual percentage rate. When a lender provides a loan to a consumer, they make a profit off of the interest paid on top of the principal amount.
• Initiation Fee
This is a once off fee which covers the cost of entering into the loan
• Service Fee
This is a monthly fee charged to manage and maintain the loan
• Consumer Protection Plan (Also known as Credit Life Insurance)
This is an insurance product that is designed to cover the cost of your total debt if you are not able to pay it back due to unforeseen circumstances such as disability, unemployment or death. Credit life insurance is mandatory on most credit arrangements and will be there for the term of the loan. A consumer will have the choice to arrange their own credit life insurance that meet the requirements of the creditor or the applicable legislation. If it is mandatory to have this on your loan and you choose to arrange your own credit life insurance, your creditor will not release any funds to you until the insurance meet their requirements.
For example, Joe Bloggs took out a loan with an accredited lender and the fee structure of his loan is as follows:
1. Principal Debt – R 4,250.00
2. Pay out Amount – R 4,250.00
3. Monthly Interest rate (fixed) – 2.06 %
4. Annual Interest rate (fixed) – 24.75 %
– Total interest charged for the period R 4,209.60
5. Service fee included in instalment R 69.00 per month
6. Customer Protection Plan – R16.85 per month
7. Number of Instalments – 60 as this loan was taken over 5 years
8. Initiation Fee – R 563.50
9. Total instalment per month (including interest, initiation fee & VAT) – R 244.82
10. Total cost of credit – R 14, 689.20
Can you see how by Joe taking out a loan of R 4,250 actually converts to a debt of R 14, 689.20 after all of the fees and interest has been charged? Interest effects the overall price you pay after your loan is completely paid off. A contract will be signed upon applying for the desired loan or credit which will outline all of the above-mentioned costs as well as any additional costs such as closing costs, administration fees and brokerage fees. It is so important to not only read but to also understand the contract that you sign with your creditor as a whole before signing.
