How do loan repayments work?

Taking out a loan is a big commitment. You will contribute towards it every month, and you need to be certain you’re aware of what this entails – especially when it comes to your repayments. But first, you need to understand how loans work in general.

When you borrow money from a lender, you will receive it in a lumpsum called a “loan”. However, this isn’t a favour that they’re doing you; it’s a business deal. In exchange for giving you access to the money you need, you agree to return the full amount – along with certain fees, such as interest payments.

There are many different kinds of loans available to you. However, they are usually divided according to the following main categories:

• Short-term loans: These are taken out to cover small, unexpected expenses, such as a doctor’s bill or paying for car repairs. They’re usually smaller than R20,000, have a slightly higher interest rate, and need to be settled in less than 12 months.

• Long-term loans: These are used to pay for larger expenses, such as big hospital bills or the capital required to start your own business. They often start around R100,000, they have a lower interest rate, and they are settled over several years.

• Revolving loans: These loans give you ongoing access to credit. For example, you can borrow R10,000, pay it back over three months, and then take out another R10,000 – without having to reapply for a new loan.

• Consolidation loans: This is a debt management tool that allows you to consolidate your debt into a single loan. It results in a longer repayment term and lower interest rate, which then allows you to pay an overall lower monthly instalment.

Loans are also classified as either secured or unsecured. The former refers to a loan that’s tied to an asset, such as a car or a house. It’s usually accompanied by more lenient terms because lenders can repossess your asset and recuperate any potential losses if you don’t meet your monthly repayments.

By understanding the different elements that are present in loans, you will be able to grasp how your repayments are structured. Let’s get started:

1. Principal debt

The principal debt is the amount of money that you initially borrow from your lender. For example, if you take out a loan of R12,000, then the principal debt is R12,000.

It’s important to acknowledge your initial debt because the amount you end up paying towards your loan will not be the same figure. This is because of the interest that gets added on, as well as any other fees, such as application and processing fees.

2. Repayment term

This refers to the amount of time it will take you to return the money you borrowed, based on the schedule that you and your lender agreed to. We can add to the above example by saying that you’re expected to return the principal amount within 12 months. This means that your instalment will, at the very least, be R1,000 per month.

If you extend your repayment term to 24 months, then your minimum monthly instalment will reduce to R500 per month. Therefore, your repayment term impacts your monthly instalment, and it can be used to negotiate lower repayments.

3. Interest rate

Your interest payments are calculated monthly, and it’s added to every instalment. According to the National Credit Regulator, lenders are not allowed to charge you an interest rate of above 21% plus the current repo rate on a personal loan.

This means that the state of the repo rate will impact the interest rate that you’re given when you take out a loan. On top of this, unless the interest rate remains fixed for the duration of your loan, your monthly repayments will increase as the repo rate increases.

The interest rate on your loan is the ongoing price – or the “fee” – that you will pay for having had access to money that didn’t belong to you yet. The interest rate will be determined by your credit profile, which includes your credit score and application details, such as your employment status.

4. Fees

There are a couple of additional once-off fees or penalty fees that you should be aware of. Have a look at the following reference list:

• Application fee: This is the cost of administering your application. In other words, it pays for the consultant or software that assists you with your application.

• Processing fee: This is the cost of processing your loan and making the necessary transactions, such as paying the money over to your account.

• Late fee: If you miss an instalment, you will be charged a late fee. This will be added to your next instalment, along with your outstanding instalment and double the interest payments.

• Early settlement fee: If you settle a large loan early (over R250,000), you will have to pay this fee to compensate your lender for the lost revenue they will face. However, you may be able to avoid this if you give sufficient notice. For example, the early settlement fee for vehicle finance may be waived if you give at least 90 days’ notice.

When you consider these elements, it becomes clear how your repayments are calculated. Every month, you will receive an invoice for your next instalment, which gives you a breakdown of these details, and you’re expected to pay it by its due date.

In some cases, you may find that your monthly repayments are larger than you would have hoped. You may become aware of this as the cost of living increases, and you find it more difficult to keep up with your monthly instalments. However, you can still take action to prevent yourself from missing payments.

Your first action should be to reach out to your lender and explain to them how either your income has reduced or your expenses have increased. They are often understanding of this, and open to adjusting your repayments.

If this doesn’t work, you can also consider taking out a consolidation loan. While you making regular payments, your credit score improved and this means that you may qualify for better loan terms now.

For example, let’s say you took out a loan for R10,000 with an interest rate of 22% and you’ve repaid half of it. If you applied for a new loan now for R5,000, you may get a new interest rate of 19%, which means that you could pay a slightly lower interest rate each month.

When it comes to your monthly repayments, there’s always room for renegotiation – whether it’s directly through your lender or by taking out a new loan altogether. Whatever you do, just make sure you don’t skip or ignore your repayments.