This archive report was first published on 25 May 2020.
Turning Loans into a Money Minting Goldmine ¶
Published on May 25, 2020, by Waceke Nduati Omanga in Centonomy, this feature examines how you can turn loans into a money minting goldmine.
Every loan has two components: the principal and interest. The principal is the amount borrowed, and when repaid, a little more is paid on top to compensate the lender, known as interest.
For instance, if you borrow Sh100,000 from your brother and agree to repay Sh110,000 at the end of the year, Sh100,000 is the principal, and the extra Sh10,000 is the interest.
However, the financially literate borrower considers the actual cost of the borrowed money, which is the interest, before taking the loan. Most people only consider if they can afford the monthly repayments.
Let's consider a car loan of Sh1 million, payable in five years, with an interest rate of 18 per cent per annum. The monthly repayment is Sh25,393, but in five years, the total interest paid is Sh523,605, making the total amount paid Sh1.5 million.
This is referred to as 'bad debt' because you have lost money on it. Your aim should be to either minimize the use of this kind of debt or get out of it as fast as possible.
However, you can turn a loan into good debt by borrowing money to invest in assets that appreciate in value over time. For instance, if you borrow Sh1 million to buy a piece of land, at the end of the repayment period, the land will be worth more than Sh1.5 million.
Similarly, if you take out a 20-year mortgage to buy a property worth Sh5 million, at 18 per cent interest per annum, the monthly repayment will be Sh77,000. However, in the early years of the mortgage, only a small portion of the monthly repayment goes towards reducing the principal, while the majority goes towards interest.
By paying an extra Sh10,000 a month towards the principal, you can save time and money. For instance, if you take out a 20-year mortgage, paying an extra Sh10,000 a month can reduce the total interest paid to Sh6.8 million and clear the loan in 11 years.
Before taking a loan, ask yourself if you can afford the interest and if you would be better off saving money or investing it to afford the item you want. Do not let the desire for instant gratification cloud your judgment.
