When we talk of financial literacy many assume it is just about counting money, doing a simple budget or just saving. It is much more than that.
Many people would know about the three parameters above but are not necessarily financially literate. It makes a lot more difference when you have a good understanding of your money beyond making a simple budget, counting your money or opening a savings account.
Good financial literacy includes knowing when to do what with your finances. For example, when and in what investment do you make when and where? When to borrow (leverage) or when to accelerate your loan repayments?
Financial literacy also includes understanding the environment in which your money is earned or spent. While you may not have total control over what happens in the environment, you can adjust your money to maximize the good times and minimize your losses in the bad ones.
Today let me speak about dealing with debts in tough times like we are in:
- Know how your debt is priced – when your loan interest is floating (changing with the base rates), the interest is adjusted as soon as the central bank changes the base rate. For instance, with the 2% increase in the base rate by the central bank, all banks will increase loan interest by 2%. While 2% may look small in face value, it greatly impacts the total interest you’ll have paid by the time you’ve finished paying the loan. The longer the time left to complete your loan repayments, the worse the interest implications;
- Do not accept any offers for a top-in at a time like this – what many do not understand about top-ups is that it is a completely new loan facility for the entire loan amount, at the new existing market rates, not the ones that existed when you took the old loan. What the bank does is approve the entire loan, recover the outstanding loan balance, and give you the difference as a top-up. For the bank, it is a fresh loan with all the required charges of loan applications and approvals;
- When interest rates are high or increasing, accelerate loan repayments – if you already have an existing loan that you are repaying, make extra deposits regularly to reduce the repayment period. Loans are structured to recover interest first before returning the principal to you. That is why the bank keeps on bothering you for top-ups or new loans. As interest goes up like they are at the moment, it makes sense to reduce your principal balance as early as possible to reduce interest loans. That way, you reduce your interest charges in a very big way;
- Avoid taking any new loans during this period -we have returned to an era when very few if any, projects can give you a return above the interest banks will be charging. It will be worse if you are taking a mortgage for a house that is not generating any rent income. Remember a loan only makes sense if where you invest in will earn you more than the cost of the loan (what we call leverage). Most businesses now cannot give returns above 20% to justify a loan at 16%-22% interest. Even plots are unlikely to give any such capital gains to make financial sense;
- Do not be fooled by salary advance loans – this is what in technical language we call bank overdrafts. These are the most expensive type of loans and will only reduce you to a slave of the bank. If you take a salary overdraft, the bank recovers everything or a huge chunk each month. Interest is charged in advance as it is often deducted from the amount borrowed. Because your expenses each month are relatively constant, it means you can only survive the next month with another overdraft, technically reducing your dependency on the overdrafts. Salary advances simply mean you are living way beyond your means or you have overcommitted your pay;
- Prioritise your savings and investment into passive incomes – create alternative incomes from your savings, no matter how small they may be. Over time it makes a lot of difference. Those are the little small steps that eventually open the doors of financial freedom.
#Enjoy your Jamhuri day & festivities.