If you must borrow this festive season, this is how to do it

DECEMBER 9, 2015

If you need to borrow money to fund additional expenses over the festive season, the funding option you choose will significantly affect your cash flow over the following months. It is therefore critically important that you choose the right type of loan.

Assuming you need R3 000 to cover additional festive season expenses, there are a few options - a payday (one month), short term (six months) or medium term loan. Each has different implications and choosing the wrong one could place you firmly on a debt treadmill.

Rayanne Jacobson, the CEO of Izwe Loans, says, “The first consideration is whether you will be in a good position to pay back the loan. If you are on a very tight budget, there may be a case for holding back on a holiday, expensive gifts or a lavish Christmas meal.”

While your intentions may be good, your family would rather have you in better financial health and should understand if you forego some of these expenses.

However, if you are thinking of taking a loan, it is imperative that you weigh up the financial consequences so that you are in a stronger position next year.

Here are the three scenarios facing you, with less than a month to go until the end of the year.

Let us assume you earn a net salary of R10 000 a month and manage to save R1 000 each month as disposable income but do not have the liquidity for additional festive season costs.

Using the R3 000 loan requirement example, and taking into account the average interest charged by numerous lenders as quoted on their websites, a payday loan, a short-term term loan and a medium term loan have very different financial implications.

In the first scenario, going to a payday lender, you will need to repay R3 629 at the end of the first month. This will probably mean that you need to take out a further loan in month two and in subsequent months, as your monthly disposable income of R 1 000 will not cover the repayment.

Assuming you do need further loans to fill the gap, it is possible you will only achieve a positive cash position by month six, and the cumulative cost of your loan could likely be in the region of more than R5 500.

In the second scenario, going to a short-term lender (usually a six month loan), your monthly instalment will be approximately R740.16, which is far more manageable. And by month six, your total cost on the loan will be in the region of R4 441. Assuming your R1 000 disposable income per month, you will be in a net cash position of around R260 from the get go.

In the third scenario, going to a medium term lender, and assuming an eight month loan term, your monthly instalments will be a much more affordable R539.51 and you would have paid back just R4 316 after eight months. What’s more, you will have a net cash position of around R460 each month after making your loan repayment. This is clearly the best option not only in terms of your total cost, but also in terms of you being able to have enough for other expenses over the loan period.

Although the payday loan appears to be the cheapest, it is the most difficult to service and inevitably ends up being the most expensive, and pushes you onto the debt treadmill.

Another thing to consider is that the more payday loans you take out, the less chance you may have to qualify for a longer-term loan.

“Credit providers look at a consumer’s credit records, amongst other things, in establishing his/her credit score. There is the possibility that regular and ongoing use of pay day loans is indicative that the consumer is in a debt trap and could, therefore, pose a greater risk,” Jacobson says.

Both the six and eight month loan terms ensure you do not overcommit, and the payment terms will not leave you in a cashflow crunch. Your ability to have financial flexibility, responsibility and maturity is impaired when you go into payday lending, so check out all the options - and implications. The cheapest loan may not be the cheapest a few months down the line.