Ins and outs of loan agreements

02 Mar 2012

Many consumers do not understand the difference between secured and unsecured loans as well as their cost and legal implications.  

“What the consumer effectively ends up paying depends on their payment behaviour, the term of the loan as well as additional fees and charges that may be added to the principal debt,” says Mphahlele.

The National Credit Act (NCA) provides for different types of credit agreements, each with a different interest rate. With a secured credit agreement, the credit provider retains a pledge or title to any moveable property like a car or a house or any other thing of value like an insurance policy or other valuable item – allowing the lender to sell the asset to recover any outstanding debt in the case of default.  

Where the amount received in the sale of the item does not cover the full outstanding amount, the consumer still has to pay what is called the shortfall. 

“In the case of unsecured loans credit providers must rely on a consumer’s risk score which takes into consideration the consumer’s affordability and payment profile,” says CEO of the National Debt Mediation Association (NDMA), Magauta Mphahlele. 

“They also rely on effective collection mechanisms and payment systems like salary deductions and debit orders, which consumers consent to when they enter into the credit agreement.”

Because of the lack of security and the higher risk associated with an unsecured loan, credit providers are allowed to charge higher interest rates on unsecured loans. Under the NCA, the maximum amount of interest, based on the current repo rate, that a credit provider can charge on an unsecured loan is 32,1% per year.  

For short term credit agreements the permitted interest rate is at 5% per month. This is for amounts less than R8 000 and a term not longer than six months. This equals a rate of 60% per year. 

For mortgages the current maximum is 17,1% per annum and for credit facilities, such as credit cards and overdrafts it is 22,1% per annum.

“What the consumer effectively ends up paying depends on their payment behaviour, the term of the loan as well as additional fees and charges that may be added to the principal debt,” says Mphahlele.

Banks as well as non-banks, such as micro lenders, clothing, food and other retailers provide unsecured types of credit, which in most instances come in the form of personal loans, overdrafts, credit and store cards. 

Consumers should ensure that they borrow from reputable credit providers. This they can do by checking if the credit provider is registered and therefore regulated by the National Credit Regulator (NCR).

One way of doing this is by identifying if the credit provider has an NCR certificate (with the NCR credit provider number), which is usually displayed by the entrance/wall of the credit provider’s premises. 

“Smaller micro lenders are not required to register but they are still required to comply with the law,” says Mphahlele.  

“In such cases the consumer must ensure that they are charged legal interest rates and fees and that illegal collection methods such as the retention on ID books, pin codes and bank cards are not used.”

The NDMA advises consumers to shop around and get different quotes as not all lenders charge the maximum amount of interest allowed under the Act. It is also advisable that consumers request a “dummy” statement so the credit agent can clarify the document as some credit providers provide complex accounting statements that some consumers cannot interpret.

Negotiate a lower rate, especially if you have other or previous accounts in good standing with the institution, she adds. “Bargaining for an initial reduced rate is easier than trying to reduce the rate on an existing agreement or credit facility.”

She explains that this means you need to pay your accounts regularly on due dates to build up a reputation as a good customer. “By keeping a clean credit record, you will ensure that you have more bargaining power.”

The best use of unsecured credit is where the consumer is experiencing an immediate or long term benefit by buying now instead of later. For example, paying school fees upfront for the full year can earn a significant discount but this should be weighed against the cost of the credit itself.

“But consumers often use unsecured credit to buy luxuries and this is one of the major causes of over-indebtedness,” says Mphahlele.  

While it is up to the consumer what they use the money they have borrowed for, she advises the most productive uses include funding education or starting a business.

She says all credit obtained using unsecured borrowing should be budgeted for in advance and the consumer should be able to settle all  loans within a relative short period, such as 6 to 12 months. 

“If you’re starting to buy food and clothing on credit and paying these off over long periods, it could be a danger sign that you’re headed for over-indebtedness.” 

Mphahlele also suggests paying off both secured and unsecured loans over a shorter period than contracted where possible, by paying off more than you are required each month.  In terms of the NCA, consumers are entitled to settle the account early and depending on the size of the agreement may do so without giving notice or paying any penalties.

Credit providers are entitled to add interest and other fees and costs up to the settlement date. To avoid early termination charges in the case of a mortgage or other large agreements consumers must establish if they need to give notice and for how long.

If you do default on your payments, even unsecured lenders will pursue the option of selling any of your assets as part of the legal and collections process, but mainly after they have exhausted other remedies such as securing an emolument attachment order which is commonly known as a garnishee order. 

Consumers must attend court if summonsed as this presents an opportunity for them to present their circumstances, which will be taken into consideration when the amount to be deducted from their salaries is determined. 

If you find you are unable to pay your monthly instalment contact your credit provider as soon as possible and try to negotiate a plan to bring your payments up to date or restructure your obligations. If you can’t reach agreement, then contact the NDMA for assistance and advice.  

“It is highly advisable that consumers obtain knowledge of how the legal collection process works as this will ensure that they request assistance at an early stage, thereby avoiding ending up with a judgment against them,” says Mphahlele.

Top tips

Key questions to ask your credit provider before signing any credit agreement:

  • How much is the total amount borrowed including any extended warranties, levies, license fees, initiation and service fees, etc.? Can any of the additional items be paid upfront to reduce the total amount borrowed?
  • How much interest will be charged over the term of the agreement and will it be fixed or variable?
  • What is the security that will be received or pledged?
  • How will the instalments be paid and on what dates (debit order, payroll or self-payment)?
  • What additional (add-on) products do you agree to by signing the document?  What additional cost are these going to add to the amount borrowed?
  • Is there credit life insurance, how much does it cost per product and what are its benefits? How does it compare with other products in the market? What is your right to take out your own insurance policy and not accept the one suggested by the credit provider?
  • Exactly what total amount should be repaid per month and for how long?
  • When will you receive statements, how often and via what mode (post or email)?
  • What are your rights and obligations in respect of cancellations, early settlement and voluntary surrender?
  • What process will be followed if you default and who should you contact should you experience payment difficulties? What default administration and other collection costs will be charged to you in case you default?
  • What is the process to lodge disputes – does it mention e-mail references and contact numbers?
  • How will your personal details, account information and payment behaviour be shared with the credit bureau and what are your rights and responsibilities in this regard?
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