COMMON PRACTICES

Most lenders engage in a practice of loading the principal. Generally, lenders add an amount to the amount you want to borrow in the guise of an upfront fee before instalments are calculated. What this means is that not only do you have to pay back that amount of this upfront fee but also the interest that will be raised on that fee. As someone who borrows you may ask the lender not to load the principal but rather that you will pay those upfront fees on initiation on the deal, or when the first payment is due.

floating or non-floating

Depending on the type of contract you sign interest rates used to calculate interest amounts during the course of the deal may be of two types, namely floating interest rates or non-floating interest rates. Non-floating interest rates do not change during course of the deal. If the lender at the beginning of the deal quoted you 10% then for the course of the deal it will be 10%. The benefit of non-floating rates is that your instalment will never change. Whereas floating interest rates may change through the course of the deal. Usually it is linked to prime rate as quoted by the major banks from time to time. This means that the interest you will be charged may be different to when you were quoted by the lender. Depending on your view of the economy and how interest rates may change, float rates may be beneficial or burdensome.

Depending on what and who you are lending, lenders have a choice in the way they quote the rate to you. If you are unaware of these subtle differences it can mislead you in comparing lenders offerings. The first item to take note of is weather or note the interest rate quoted is an annual interest rate or not. Some lenders like to quote monthly rates as oppose to annual rates. The important thing to remember is that it looks cheaper on the surface when compared to other interests which is quoted on an annual basis. The second aspect some lenders practice is to quote rates as either nominal or effective, this means the rate either include compounding or d it does not. Generally, lenders do not include compounding as it makes their interest rates look higher.

If you are familiar with prime rate, then this is considered a Nominal annual compounding month rate(NACM). Nominal(N) because it does not take into account compounding when quoting the rate, Annual(A), because it is quoted for a 12-month period and compound monthly(CM) because the rate quoted reveals how compounding will occur.
Let look at some examples below
You borrow R1000 at the beginning of the year. You do not make any repayments toward it.

If you have a nominal annual rate of 12%, compounded annually (NACA) then, at the end of the year, they will apply 12% interest to your balance. It will be R1120.
The effective annual rate will be 12%.

If you have a nominal annual rate of 12%, but compounded monthly(NACM) then, at the end of each month, they will apply 1% interest to your balance for that month (12% / 12 months):

After month 1 it will be R1010
After month 2 it will be R1020.1 (interest is 1% of R1010)
After month 3 it will be R1030.3 (interest is 1% of R1020.1)
etc.
After month 12 it will be R1126.82

in the above NACM case the effective annual rate is then 12.68 which is higher than the quoted 12.00%

If you have a nominal monthly rate of 12% (NMCM), then at the end of each month, lenders will apply 12% interest to your balance.
After month 1 it will be R1120
After month 2 it will be R1240 (interest is 12% of R1000)
After month 3 it will be R1360 (interest is 12% of R1000)
etc.
After month 12 it will be R2440
The effective annual rate is then 144%. as you see there is a big difference

Bow you can see the effective rates vary across the different ways a lender can quote rates to you. As a borrower you should be wary of the 3rd example. It is often used in calculations using the fixed rate method.

One aspect of the reducing balance method of calculating instalments is whether or not your repayment will begin at the beginning of the month(advance) or at the end (Arrears).
The outcome of this aspect reduces the instalment if the calculation is charged in advance or increase the instalment if the repayment is calculated in arrears. The significance of this aspect will determine whether you will have to pay and instalment as soon as you receive the loan or only repay at the first repayment date.
An example:
You borrow a R1000 over 12 months with a NACM rate of 10%
Advance instalment is R87.19
Arrears instalment is R87.92

Another aspect of the reducing balance method of calculating instalments is residual or sometimes called future value. This aspect crops up when there is an asset involved with the finance, because the asset useful life is usually longer that the period of finance. Let’s take for example a car which has a useful life of 8 years but you want to take finance for 3 years. A financier may in order to make the instalment price more attractive include a residual amount in the calculation. The residual amount equates to the value of the car after the finance term has ended. This means that at the end of the finance term the car will not be fully paid off and the residual amount is outstanding.
Take for example:
A new car valued at R120000, the cars useful life is estimated 10 years. You decided to take finance for the car. The financier decides that the car after 4 years will be R50000. He offers a payment plan at a rate of 8%.
The payment plan with residual will be R 2042.24 for 48 months ate the end of the 4 years the balance owing would be R50000.
Assuming there was no residual The payment plan would be 2929.55 and at the end of the term the amount owing would be nil.
As you can see the two instalments are nearly a R 1000 in difference. If you are sensitive to the instalment amount at the time of finance, the residual option may work for you, however always keep in mind of a ‘balloon’ payment at the end of term.

Generally, when you take out finance, lenders often charge you monthly fees to cover the cost of administrators or collection orders, they usually include VAT. One must always remember to ask how much are the fees and you should determine whether they are reasonable and within the prescribes of the law. One must always beware that if you terminate you finance at an earlier date that contract lenders may still include these monthly charges in your settlement amount. Here too you should find out as some deem this settlement practice as unfair.

Charging Insurance is a big money spinner for lending companies. Lending companies cannot force you take insurance cover offered by their firm. If you can prove that you or your business have been covered by another insurance company, then that should suffice.
Insurance products vary in terms of what they cover, you must be very clear what it covers and does not cover. Generally speaking, insurance for the entrepreneur herself is easier to obtain. Business insurance usually covers assets and at the time of writing this no insurance cover offers a general credit risk product for businesses. If your business extends credit to customers, then the insurance companies do have credit guarantee solutions.

If by chance you fall behind on your repayments to lenders, please note that lenders charge interest on the arrears amount. Generally, lenders charge interest on the arrears balance at every end of day. The arrears balance usually increases every day by the interest amount so every subsequent day the interest charged is a higher amount this is assuming no repayments are made in the interim. The best advice one could give is to make sure you pay on time. If one cannot it is better to talk to the lender and any fair lender will understand and off a solution for you.

Lenders don’t usually want you to repay quicker, they make more money if you are on their books for longer. Depending on the type of contract you enter there may also not benefit to repay faster. Sometime lender might even charge you penalties for repaying your loan faster. Always be aware upfront what you and your business are getting into. Lastly, be sure to find out how ownership is transferred if the loan is link to some asset.