Financial literacy: The do’s and don’ts of borrowing

Whenever you are in a financial fix, borrowing is always an easy way out.

Sometimes this is whether you are in a position to repay the money or not. 

And many Kenyans, especially the youth have perfected the art of borrowing.

This has been made easy by the proliferation of mobile loan apps in the country.

Other financial institutions, including banks, have also not been left behind and are cashing in on the growing demand for loans with their mobile applications.

This is a departure from the past when getting a bank loan even for the smallest amounts was such a laborious exercise.

It emerged recently that Kenyans borrowed Sh1.2 billion daily through Safaricom’s overdraft facility Fuliza last year, demonstrating Kenyans’ insatiable appetite for loans.

While sometimes it is unavoidable to borrow, it can also ensnare you in a debt trap.

But the ease of obtaining loans through the ubiquitous mobile lending apps has made it hard for many people to avoid getting into unnecessary debt.

While the red flags are in many instances evident, many people only realise they are in a debt trap when it is too late. 

Elizabeth Nkukuu, a personal finance expert, warns that one should never borrow for consumption. This includes taking a loan to upgrade your house.

“Those are not investments,” warns Ms Nkukuu.

She says even when you take a loan for investment, you should analyse the returns to ensure they are higher than the cost of the loan. Otherwise, you run the risk of getting into a debt trap.

Some investments like buying land for speculation, Nkukuu says, may not be worthwhile.

But it would make sense if you took a mortgage, especially if you are in employment and your salary allows you to.

So what of a car loan, considering a motor vehicle depreciates over time?

“When you buy a car, the first question should be ‘why am I buying it’?” she says.

“For example, if your work requires that you have a car and not having one increases your transport costs, then it is something to consider,” says Nkukuu.

Transport cost, she says, should be around 10 per cent of your total expenses.

Eric Maina,  an analyst with Mwango Capital, a research financial firm, for his part says one of the reasons you should take up a loan is if it helps reduce your expenses.

A loan should also generate more income on completion, but it is also okay to borrow for some personal needs, such as emergencies.

Read fine print

“Avoid taking loans to splurge, borrowing amounts that you cannot repay, or ongoing expenses,” warns Mr Maina.

And according to Nkukuu, one should also consider the interest rates, terms of the loan as well as fees charged.

“Read the fine print,” she advises.

Nkukuu says servicing a loan should not exceed 10 per cent of your income.

Such a situation, she warns, may force you to borrow to repay another loan.

“That is digging yourself into a financial hole. Unless you are out to get a discount (from the new lender) whereby if you are paying a loan at about 12 per cent you are getting the new loan at 10 per cent, it wouldn’t make sense,” says the financial expert.

So is there a right time for one to borrow? For instance, should you take a loan if you are newly employed or you have just started a business?

Nkukuu says one can borrow at any point as long as it is necessary.

“You should not peg taking the loan on what you are going to use that money for,” she says.

“As long as what you are going to use that money for makes sense, then you can consider (taking the loan). It could be one year or the next five years, but you should never take a loan if you do not know what you are going to use the money for.”

Mwango Capital’s Maina meanwhile, says borrowing is ideally meant to fill a financial gap in one’s budget.

“So you should only borrow when there’s a need for it. These needs will, however, differ from person to person,” he says.

Other factors to consider, Maina says, include one’s income status. This is, for instance, if one is employed or in business as this might dictate the tenure and the amount of the loan.

“Yes, income acts as collateral when borrowing, and the higher it is, the higher the amount the lender is likely to advance you,” he says.

Maina further advises that one should consider the terms of the loan, opting for those that are less stringent.

And while having a higher income offers you more options on the choice of lenders, always go for the terms that favour you the most.

“Due diligence is, however, key to avoid punitive loan terms regardless of income,” says Maina.

And even before you receive that money, have an expenditure and repayment plan. Having a plan will help you avoid financial mistakes that could drive you further into debt.

“Ensure loans taken up are utilised on the tasks for which they were intended,” he advises.

“Misappropriation of funds is likely to lead to further borrowing, which makes repayment problematic.”