In March 2021 the Consumer Credit Market Report 16% of credit granted was unsecured credit or short term credit (Source: ncr.org.za). Most of the credit granted is mortgages, these are the largest loans (39%). Secured credit made up 29%, credit facilities 14%, short-term credit 1% and developmental credit 1%.
You might be asking, what all these different types of credit, and what should I be considering when I think about a healthy credit score and purchasing a home.
The National Credit Regulator’s (“NCR”) defines consumer credit in these categories
- Mortgages: An agreement that is secured by a pledge of immovable property
- Secured credit: Vehicle, retirement benefits, insurance policy, furniture and other durables
- Credit facilities: Credit and garage cards, bank overdraft, services, store cards
- Unsecured credit: All transactions where the lender does not have security (other than credit facilities or short-term credit)
- Short-term credit: Repayment periods of less than 6 months
- Developmental credit: Educational loans, small business, building/expanding low income housing
What is the difference between these types of loans?
Essentially there are two types of loans: secured and unsecured loans. A secured loan is tied to an asset or has collateral, something with value that you can offer up in case you cannot pay back the loan. An unsecured loan is where you borrow money outright.
Examples of secured loans are mortgages and car loans. Unsecured loans can be credit cards and personal loans. Since there is no collateral, these also typically charge higher interest rates than secured loans.
The other major difference to consider is the repayment term of the loan. The shorter the repayment term, the more expensive or higher the interest rate charged. Consider carefully before taking out loans with high interest rates and short repayment periods. They can become very expensive and difficult to pay back. All this will be considered when your affordability and credit profile are assessed for a home loan.
Personal Loans, Short-term Loans and Payday Loans
A personal loan is unsecured and can either be paid over a long or a short period. The shorter the period the higher the interest rate, and more expensive.
A payday loan is also a short-term unsecured loan. As these often involve a small amount to be paid back quickly, you could easily think they aren’t that risky. However, the fees and interest rates associated with these loans are higher than most other types of loans. In particular if you miss your repayment or extend the loan, the charges quickly mount up and what started off as a small loan rapidly grows with extra interest and fees.
In fact, because of the these high costs, more often than not, payday loans do not solve cash flow problems if you are already having financial difficulties (Source: Old Mutual). The main danger with taking out a payday loan is that you may quickly get trapped in a cycle of debt. Although a payday loan is normally for a fairly low sum of money, such as R2000, it is easy to get trapped in a cycle of taking a new loan out every month to cover the same or increased shortfall.
Carefully consider before taking out loans, as it can rapidly spiral out of control and negatively affect your credit profile with missed payments.
If you have to borrow, borrow wisely!
During difficult periods like 2020 and 2021 with the pandemic and lockdowns, there are many reasons people may need to borrow and these are often for genuine emergencies such as medical, loss of jobs or a death in the family. If you have to borrow, borrow wisely! Make sure you only borrow what you need. While the maximum sum the lender can offer may seem appealing, if you don’t need it, then it’s not worth the high repayments.
Make sure you need to borrow the money for a real emergency, and not for any nice to haves. During 2020, some people took out emergency loans which they cannot account for now 12 months later or remember what the money was spent on.
If you did take out short-term loans and unsecured loans
The best advice is always, pay off your debt as quickly as possible and then build up savings over the longer term. Start by making a list of the debt you owe, the amount and interest rate charged on each. Then tackle each amount one at a time. In our next monthly mailer we will talk about the different methods of tackling debt.