What Debt Relief Means For You!

Since the confirmation of the first COVID-19 case in Kenya on 13^th March 2020, the number of new infections has been on an upward trajectory. As a result, Kenya, just like other countries around the world has put strict measures to reduce the spread. Unfortunately, these measures have had major implications on the economy. The markets have been crushing, businesses have closed down, and employees have been forced to take pay cuts or worse, lost their jobs.

To ease the impact of COVID-19 on the economy, the government recently announced a series of measures with one of them being the reduction of the CBR rate by 1% and request to financial institutions to offer relief to their borrowers.

On the same note, last week, I received an email from my bank stating that they will be offering the below relief measures to assist manage the economic impact of the pandemic. And that our personal account managers will be calling us to discuss which option best suits us.

1. 3 months repayment holiday;
2. Extension of the tenure of the loan up to 12 months; and
3. Option to pay interest only, for 6 months.

Debt relief can take a number of forms and different financial institutions are offering different options. So what has your bank offered you and what do the options mean for you?

Today I want to discuss the above options offered by my bank, (which I think are the most commonly offered type of relief by most banks) to help us understand the effect it will have on our loans and mortgages.

With a 2.5M personal loan with a 5 year repayment period at the current 12.5% interest rate, the monthly repayment amount is Kshs 56,245. Currently, the balance is Kshs 1,359,891.

So, if I decide to take option one of 3 months’ relief, what happens to my loan account? For the next three months, I am not expected by the bank to make any payment. This is great since I will not incur penalties and/or late fees for nonpayment. However, that does not mean that my loan account will remain static. At the end of each month, the bank still expects to earn money from me for using their money. However, since they have given me a holiday, they expect to be compensated in the future hence, they will add the interest amount owed in month one to the outstanding principal amount.

Mathematically, at the end of April, I am expected to pay Kshs 56,245 of which Kshs 14,165 is interest. The bank will, therefore, add the Kshs 14,165 to my outstanding balance. Do note that as the outstanding balance increases so does the interest. At the start of the 4^th month, my outstanding loan balance shall be Kshs 1,402,831.  The bank will then use this amount to recalculate the loan and come up with a new monthly repayment amount which I shall be expected to pay from month 4. In my case, it shall be Kshs 64,027. Due to the increased outstanding balance, I will end up paying more in interest in the long run.

If I decide to take option two,  that means the bank will increase the loan period by 12 months, My loan will no longer be a five-year loan but a six-year loan. The bank will recalculate the loan using the new loan period. The increased period lowers my monthly loan repayment from Kshs 56,245 to Kshs 42,177 reducing my debt obligation in the short term, however, in the long run, I will still end up paying more in interest. Do note, the bank will expect me to pay the Kshs 42,177 every month (including during this partial lockdown period) and will incur penalties and/or late fees if I fail to make my payments in a timely manner.

Lastly, if I decide to take option three, I shall pay the Kshs 14,165 in monthly interest for the next six months. That means, the outstanding principal amount remains constant over the six months. For me to complete the loan at the agreed 5 years, at the end of the six months, the bank will have to recalculate a new monthly payment to recover the lost six months that I did not pay towards reducing the principal amount. The new monthly payments shall be Kshs 69,486 which I shall be expected to pay from month 7.

So, before you take any debt-relief options, do your research and understand the impact it will have on your loan account. If possible, always ask for professional help.  And never forget you can always negotiate, you don’t have to take what they are offering. The banks have been quite considerate during this corona pandemic period, but at the end of the day please remember banks are out to make the most money from you.

Finally, if you do not need debt relief and can afford to make your minimum payments, please don’t take it just because it is being offered. The cost of a loan is determined by the interest rate, time and amount owed. When either of those is increased, the cost of your loan increases. As I have shown above, all these options will result to, a higher interest payment in the long term than I would have paid before. Therefore, except, if the relief reads something like your lender is willing to waive your interest partly or completely during this period, think through the offer before accepting it.

PS: None of the content in this blog is financial or investment advice. It’s for educational purposes only. Please do your own research and/or consult with a professional if you want advice customized to your specific situation.