Debt Headache? Time to take control!

Debt is usually in the form of loans, mortgages, bank overdrafts, etc. and it can be taken by individuals or corporates. The financier can be a bank, SACCO, microfinance institution, one’s employer, shylock, etc. Debt may be used to purchase assets or to finance recurrent expenditure like rent, food and salaries. In repaying the debt to the financier, one pays not only the amount received (principal) but also the interest charge.

The COVID-19 pandemic has slowed the economy, thrusting both individuals and corporates into financial distress due to illness, reduced incomes or uncertainty of cashflows. Debts that were previously serviced ‘automatically’ by standing orders or check offs are quickly becoming a festering sore. There is always a temptation to ignore such a situation and await normalcy. However, it is prudent to accept change and take control; to set sail rather than to drift.

When faced with arrears in debt repayment, some of the options that one may consider are:

  1. Insurance – Most mortgages have mortgage protection insurance. If the terms of the insurance policy cover inability to service the mortgage due to illness or job loss, then one can engage the financier so that some of the debt repayments are covered under the policy.
  2. Debt Restructuring – This is discussed in detail below.
  3. Disposal of Asset(s) – A borrower/debtor may dispose of some asset(s) e.g. land, vehicles, shares, etc and utilize the funds received to pay off their debt. Most times, this is an option of last resort though one may take it up early if other options are not feasible.

Debt Restructuring

Due to the ongoing pandemic, the Central Bank of Kenya (CBK) has directed banks to provide relief to their customers/borrowers for one year, starting March 2, 2020. CBK has facilitated this relief by lowering both the Central Bank Rate and the Cash Reserve Ratio by 1%, to 7.25% and 4,.25% respectively. With the lower rates, the banks can offer loans to borrowers at lower rates, as well as access more money/higher liquidity for lending.

CBK has advised that relief to borrowers should be provided based on individual circumstances arising from the pandemic. Notably, some financial institutions and SACCOs have responded to their customers’ predicament by independently announcing reduced interest rates or favourable repayment terms.

In light of the foregoing, what are the options for debt restructuring?

  1. Full moratorium – Payment of both principal and interest are suspended for a specified period. The borrower is also shielded from credit default listing.
  2. Reduction in payments – The loan repayment is reduced to an amount that is convenient to the borrower. Despite this reduction, the borrower’s credit rating is not affected.
  3. Reduction of interest rate – The financier can reduce the interest rate on the loan.

Where there is a reduction on loan repayment amounts [(b) above], it is critical for the borrower to confirm whether interest accrual can be suspended or if the interest rate can be reduced. Suspension of interest accrual is extremely favourable to the borrower, since any repayments are channelled towards reduction of the principal amount. The examples below illustrate this point:

 Illustration I – MR. GITONGA

Gitonga, a successful businessman, purchased a 3 bedroomed apartment in Kitengela for Kes 5 Million. The interest charge on the facility has been 14% p.a. on reducing balance and he has been paying Kes 70,000 per month since January 2014. Following the COVID-19 pandemic, his income has dwindled and his financier, the SACCO, has granted borrowers a 5-month full moratorium. He notes that the interest charge for the current month is Kes 15,000 which he can comfortably pay for at least 5 months.

He wonders whether to take advantage of the moratorium by not making payments for the next 6 months, or to pay the Kshs. 15,000 for the next 5 months. We assist him in crunching the numbers and the workings are summarized in the table below.

  Loan Repayments  Interest (Kes) Total Payments (Kes) Period (Years) Effect
1. Normal (P + I) 5.8 M 10.8 M 13 Normal
2. Principal (P) Only

Interest suspended

5.5 M 10.5 M 12.8 Kes. 300,000 less
3. Interest (I) Only 6.2 M 11.2 M 13.4 Kes. 400,000 more
 

By paying Kes 15,000 for the 5 months Gitonga will eventually have paid Kes 300,000 less in interest, and will finish paying off the loan 2 months ahead of schedule. He therefore opts to reduce his monthly repayments from Kes 70,000 to Kes 15,000.

It is important to note that if he pays the Kshs. 15,000 but interest continues accruing at the rate of 14% (no moratorium on interest), he will eventually pay Kes 400,000 more in total interest and the payment period will require a 7-month extension.

Illustration II – MS. VICTORIA

Victoria purchased her Toyota Vanguard in July 2018 for Kes 2 Million using a bank facility charging interest at 14% p.a. on reducing balance. She has been making monthly loan repayments of Kes 55,000. Following the COVID-19 pandemic, she is on unpaid leave and is having difficulty servicing the loan.

Her bank has expressed willingness to accommodate borrowers who have been adversely affected by the pandemic, by reducing their repayment amounts. She can pay the interest component which is Kes 40,000 as at April 2020. She wishes to understand the effect of reducing her loan repayments from Kes 55,000 to Kes 40,000 for the next 5 months so that she can engage the bank’s relationship manager with a proposal.

The summary of our workings is tabulated below.

  Loan Repayments  Interest (Kes) Total Payments (Kes) Period (Years) Effect
1. Normal (P + I) 0.62 M 2.62 M 4 Normal
2. Principal (P) Only

Interest suspended

0.59 M 2.59 M 4.3 Kes. 30,000 less
3. Interest (I) Only 0.69 M 2.69 M 4.5 Kes. 70,000 more
 

We inform her that the reduction in loan repayment will cost her Kes 70,000 more in total interest if interest accrual is not suspended. The repayment period would also increase by 6 months. If the bank agrees to suspend the interest for the 5 months, the total interest payable on the loan would be Kes 30,000 lower while the repayment period would increase by around 4 months.

Based on this information, she drafts a proposal for reduction of her repayment amount from Kes 55,000 to Kes 40,000 for the next 5 months. She also proposes the following options in order of priority:

Option 1 – Request for suspension of the interest charge for the 5 months

Option 2 – Request for reduction of the interest charge from 14% p.a.

Evidently, Victoria is well prepared to meet the bank’s relationship manager and to engage in judicious negotiations.

Loan Rescheduling

Ultimately, the loan (principal plus interest) will still need to be repaid in full. A moratorium or a reduction of payments usually results in underpayment of the loan with reference to the original schedule. Such an underpayment can be regularized after the period of financial distress by:

  1. Paying a lump sum to cover underpayments;
  2. Increasing periodic payments for a definite period then reverting to the original repayment amount; or
  3. Resuming original repayments, but extending repayment period

These terms should be agreed upon with the financier at the time of restructuring the debt, to avoid conflict and misunderstandings at a later date.

Finally

  1. Understand your debt position;
  2. If you are undergoing financial distress, explore the options available i.e. for debt restructuring;
  3. Consider the overall impact of debt restructuring; and
  4. If you have to, then restructure your debt by negotiating favourable and well-informed loan repayment terms. Do not rush to restructure your debt if it is not necessary, unless you want to take advantage of favourable terms like suspension of interest.

Should you require assistance in managing your debt or other personal finance matters, you can reach Charity on invest@parexcellence.co.ke or charity@parexcellence.co.ke

Financial Investment Plan: The WHEN

You may be wondering at what point in life you should prepare your Financial Plan. The basic rule is:

  1. When you are earning an income; and
  2. You have not already documented your Financial Plan.

It is extremely urgent to document it if:

  1. Your salary does not last until the end of the month;
  2. You have assets that are not generating any income;
  3. You panic at the prospect of losing your job;
  4. You take salary advances or other soft loans;
  5. You use your credit card(s) regularly;
  6. You keep on wondering where your money goes every month;
  7. You do not have an income-generating asset despite receiving an income for several years;
  8. You have access to a substantial amount of money, but you do not know what to do with it;
  9. You are feeling overwhelmed by debt; or
  10. You have many ideas on how to invest your money, but you have not implemented them.

Your Financial Plan should be revised:

  1. When there is a significant change in incomes, expenses or debts;
  2. After acquiring an asset with a huge capital outlay;
  3. Following the periodical evaluation exercise;
  4. Upon occurrence of a major social event e.g. marriage, death of a close family member, retirement, divorce, etc; or
  5. Following a change of strategy and goals.

Your Financial Plan is a dynamic tool that will grow with you, evolve with time and eventually deliver you to your destination. Quoting Napoleon Hill, if you do not see great riches in your imagination, you will never see them in your bank balance!

Preparing for the Unexpected

As fish are caught in a cruel net,                                                                                                                   Or birds are taken in a snare,                                                                                                                         So men are trapped by evil times                                                                                                                 …that fall unexpectedly upon them.                                                                                                                                                               Eccl. 9:12

This month a number of us were affected by the placement of Chase Bank under receivership. While depositors could not access their money, the employees could neither access their money (since most of them bank with Chase) nor could they ascertain their employment status.

Both the depositors and the employees were trapped-by-evil-times-that-fell-unexpectedly-upon-them. Unfortunately, such nightmares will occur in each of our lives though in different forms. It is just a question of when. What makes the difference is our level of preparedness.

Some of the unfortunate circumstances that may befall us include loss of a job; illness; natural disasters wreaking havoc on our homes, cars and properties; theft; accidents; political unrest; etc. While we cannot fully shield ourselves from the consequences of these events, we can reduce their impact by anticipating them and making adequate provision. We shall focus on financial preparedness, since all these situations ultimately affect our finances.

One of the ways of making financial provision is by having an emergency fund. The fund should be fairly accessible and if possible should earn interest. It is also important for the fund to consist of a diversified portfolio. For example, the fund may be distributed between an interest-yielding bank account, a money market fund, SACCO deposits that can support an emergency loan, etc. Diversification also means that if your SACCO banks with Bank X, your bank account holding your emergency funds should be in Bank Y. The structuring of the emergency fund is therefore very critical and it calls for careful thought.

How much should we accumulate in the emergency fund? An equivalent of 3 to 6 months worth of expenses is usually adequate. Since most people spend 40% of their gross income on living expenses, the ideal emergency fund can be estimated at 1.5 to 2 times of one’s gross monthly income. Adequacy largely depends on the stability of your current income, flexibility of your expenses, diversification of your income streams, stability of the macro environment, etc.

When the emergency kitty has a healthy balance, all situations around us might start looking like emergencies. However, we should resist the temptation to access the fund unless faced by a real emergency. The test for checking whether a situation qualifies to be an emergency is: Is it unexpected? Is it necessary? Is it urgent? If the answer to all three questions is yes, then you are likely handling an emergency.

The second solution on financial preparedness is insurance. The market has various insurance products that cover property loss, medical expenses, disability, untimely death, accidents, education expenses, professional liabilities, etc. An appropriate insurance cover will effectively shield you from expenses that can be otherwise crippling. You should evaluate potential risks and then negotiate an appropriate cover with a stable insurance firm.

The provisions made in anticipation of evil-times-falling-unexpectedly-upon-us have various benefits which include:

  1. Stress reduction – You do not keep on worrying about what will happen in case misfortune strikes.
  2. Increased income – Your emergency fund will earn you income.
  3. Reduction of expenses – You will not resort to expensive loans to sort out emergency situations.

We live in a world where change is inevitable. Are you ready for the unexpected? Is your emergency fund in place? If not, now is the time to start!

The Seven Financial Virtues

You have big dreams of what you would like to achieve in your lifetime: assets to own, destinations to explore, ‘fat’ bank balances and peace of mind among others. These dreams can be realized by receiving an inheritance, marrying into wealth, winning the lottery, stealing or a just earning.

Whereas the first four options guarantee a quick solution on how to make your dreams come true, it is only the last option that will stand the test of time. Now, there is a catch! These dreams can only be achieved if the just earning is received by a person with Financial Virtues.

We have a checklist of Seven Financial Virtues. Do you have:

A Vision

You have painted a very clear picture of what you hope to acquire within a given period.

A Strategy

You have a game plan (Financial Plan) on how to make your vision a reality.

Discipline

You consistently follow your game plan (Financial Plan), and any changes are made deliberately.

Decisiveness

You have the ability to say ‘No’ to actions, habits and persons (including yourself) that are not in line with your vision and strategy.

Prudence

You think carefully before making any decision that affects your finances. You do research and seek professional guidance before making a major financial decision.

Thrift

You are careful about how you use your money. You are not wasteful.

Patience

You understand that your financial journey is a marathon not a sprint. The gains are made in small steps and over a long period of time. You believe that if it’s too good to be true, then it’s too good to be true.

If your answer is Yes to each of these Financial Virtues, then you are well on your way to achieving your dreams. If you have some No responses, now is the time to say YES!

The Journey to Financial Independence

One of the most exciting achievements in life is the attainment of Financial Independence. If it was a moment in time, we could probably hold a week-long celebration. However, it is a gradual process that requires careful planning and sacrifice meaning that the toast rarely happens.

Perhaps you are wondering what Financial Independence is and why anyone should celebrate it. A person is said to be financially independent if they have assets/investments that generate an income that exceeds their living expenses. Why this calls for celebration is because you can finally enjoy a ‘work-free’ life! Let me explain.

The journey to Financial Independence is all about receiving an income, managing your income, growing your income and empowering your income. This is quite a mouthful, so we have broken it down into 10 steps:

  1. Start earning an income.
  2. Distribute your income between savings and living expenses. Make sure you save a minimum of 15% of your income. If you have any debts, start repaying them immediately.
  3. Set your sustainable living standard. Keep in mind that you should live below your means.
  4. Use your savings to grow your emergency fund; to purchase furnishings, house, car, etc (Items); to advance your education and to purchase income-generating assets (Investments).
  5. If you purchase a house, car, etc (Items) on loan, try to buy them at a reasonable price, get the lowest interest rates and fast track your repayments. Never incur debt to finance household expenses. Remember to maintain your savings at 15% of your income (or higher).
  6. Make effort to constantly increase your income.
  7. Use the incremental income to fast track debt repayment and to purchase income-generating assets (Investments). Do not fall into the temptation of upgrading your living standards, unless it is absolutely necessary.
  8. Use the income from your Investments to pay off any debts incurred in their acquisition. This is possible only if the incomes are received in cash. Where the incomes/gains are not realized like in the case of appreciation in land value, use your other incomes to pay off the debts.
  9. Finish paying off the debts on your Items and keep on growing your Investments.
  10. Use the income from your Investments to cater for your living expenses. If the incomes from your Investments fully cover your living expenses and your debts are paid, then you are financially independent!

At this point as long as your investments are safe and you maintain your sustainable living standards, you can wake up every day to smell the flowers. If you opt to continue working for an income, you can choose between increasing your investments, upgrading your living standards or giving to philanthropic activities. Whatever option you take, you will be peacefully excited to wake up every day.

Have you started your journey to Financial Independence? If not, it is not too late to start.

Have you lost your way and you need to get back on track? You can use the tips below:

  1. Adjust your living standards (downwards) to a sustainable level. Live below your means.
  2. Fast track your debt repayments for Items previously purchased. You can sell them off if necessary.
  3. Start purchasing income-generating assets (Investments).
  4. If possible, increase your income.
  5. Continue following the steps discussed above.

 

NOTE: If you intend to live off your pension during your golden years , do the maths and build up your pension to a predetermined amount. You will also need to keep working until your official retirement.

 

Exploring the ‘WHY’ behind spending

Many times we do not give a lot of thought to how we spend our money, yet we spend a lot of our time worrying about unmet needs. It is therefore important to investigate how we spend our money and why we spend it. Today we look at the WHY.

There are various reasons why we spend our money, and we have enumerated a few below (in no particular order):

Basic needs

Food, shelter, clothing, education and health care are some of the basic needs a human being requires to survive in this day and age.

Comfort

Whereas we can access basic needs at a suboptimal level, we constantly strive to improve their quality so that we can enjoy a higher level of comfort and increase efficiency. The increased comfort and efficiency comes at an extra price. Examples are a bigger house, sourcing protein from meat instead of legumes, having several changes of clothing, cooking using gas instead of firewood, etc.

Luxury

Luxury items are not necessary for a person’s survival, and they do not increase efficiency. They are usually status symbols; marks of prestige. One would purchase luxury items to appear successful and to stand out from the crowd.

To generate income

There is a proverb which says that ‘you reap what you sow’. This truth applies to economic aspects too. One needs to spend money as business capital in order to earn a profit. Even employees spend on transport and grooming so as to sustain their employment.

Keeping up with the Joneses

Sometimes we buy things because our neighbor, colleague, enemy, etc has acquired that item. We may not need it, but the purchase will make it easier for us to blend in with our crowd. That car, outfit, television, vacation, exorbitantly-priced school, etc

A way of life

We may have been nurtured by our parents/care-givers to spend; and by that I mean extravagance. Having perfected that skill, we unconsciously look for the next item to purchase without giving the transaction too much thought.

Addictions

If one is addicted to food, gambling, movies, alcohol or shopping, they will engage in activities that seem to satisfy their addictions. Such activities usually cost money.

Seek happiness

Most of us cherish happiness and sometimes this comes at a price. Going on vacation, having a spending spree with friends, indulging in alcohol and other entertainment activities all leave our pockets emptier.

Obligations

We have obligations that drain our money, and these may be legal, religious, societal or self-imposed. Legal obligations include payment of taxes and other government levies. Religious obligations include payment of tithe while at a social level we may feel obligated to give back to society.

Blessings & Affections

One of the attributes that we all aspire to have is generosity. Indeed, there is a blessing and a satisfaction that comes from giving. We give to religious causes, to family members and towards development of our communities, and that affects our income statement.

Expenditure is inevitable. However every time you hand over your money or card (debit/credit) to someone else, remember to ask yourself WHY! You might change your mind and save an extra coin.

Financial Investment Plan: The WHY

We strongly encourage every person to prepare their financial investment plan (FIP). Exactly why is a FIP important? There are various reasons why the FIP is the best tool one can possibly use to manage their finances. The major benefits are:

Financial Status at a Glance

The FIP gives a summary of incomes received, taxes paid, debts repaid and expenses paid for over a given period of time. This summary is used to compute (in percentages) how your earnings are distributed between the different expense items.

The information so presented provides an invaluable tool for planning and decision making.

Know your Net Worth

Do you know your Net Worth? Do your liabilities exceed your assets? No? Yes? I don’t know? I’m not sure? I can estimate?

All these are possible answers, but the ideal one is No. If your answer is ‘No’, by how much do your assets exceed your liabilities? It is important to have a figure.

If your answer is Yes meaning that you are deep in debt, what is the level of debt? Such knowledge would be a first step towards walking away from your financial troubles.

Control

The FIP documents your recurrent expenditure and you will be surprised to realize that a huge chunk of your income goes towards unnecessary expenses which can be eliminated altogether. Such monies can then be redirected towards debt repayments or savings. By so doing, you will have better control over your finances.

Create Financial Goals

Perhaps you have been saving or better still, investing. Why are you saving or investing? To: Buy a car? Purchase property? Further your education? Fund children’s education? Build emergency fund? Go on vacation? Save for retirement?

The FIP will help you identify your financial goals. These financial goals will help you quantify how much you should be saving, determine the best investment vehicle for such savings and more importantly, they will motivate you to achieve the targets that you set.

Stipulate Timelines

The FIP defines the timelines within which each financial goal should be achieved. This increases the element of control and assists in planning. Instead of living one day at a time, you can forecast the activities you will be engaging in during future periods. For example, undertake Masters Degree in year 2018; purchase land in year 2019, start building a family home in year 2022.

Asset identification, valuation and optimization

The FIP records the assets you own, when you purchased them, their value at the time of acquisition and their current value. This information can then be used to determine the optimal use of each asset.

For example a plot of land purchased several years ago at Kshs. 300,000 may now be worth Kshs. 2,000,000. It may also have better access to water, electricity and social amenities. One may decide to develop it; to sell it and pay off an outstanding mortgage or to sell it and start a business. The FIP will prompt you to constantly think about your assets and assist you in making informed decisions about their best use.

Motivation to earn more

Once you put together the FIP, you will have higher regard for your shilling. Inevitably, you will look for ways to increase your earnings so as to achieve your financial goals within a shorter period.

Understand your debt

You may be having some outstanding liabilities which may be in the form of bank loans, SACCO loans, credit card balances, mortgage, loans from friends and family, etc. Most times, debt comes at a price in the form of interest. You will be required to repay the amount you have borrowed together with the interest charged.

It is critical to know how much you will pay as interest for any debts that you currently have. This will give you an opportunity to explore alternative avenues of financing to mitigate the interest charge, reorganize your loan repayment schedule and guide you in making future decisions on debt financing.

You may be surprised to learn that the SACCO loan of Kshs.500,000 you took at an interest rate of 12% p.a. will have cost you Kshs.200,000 (interest) over a four year repayment period.

Informed Investment Decisions

Having documented your incomes, expenditure, net worth, assets, debt levels and financial goals; you will be fully equipped to make decisions on how much to invest and the period of each investment. We may assist you in determining the investment product that matches your need, although even this may not be necessary due to the interactive approach that we adopt in developing you FIP.

Evaluate Progress

Your progress towards achieving your financial goals will be monitored using the targets that you set for one, three and five year periods. You will be encouraged to informally monitor your progress for three and six month periods in the course of the first year. Periodical review of the FIP is also vital especially when there is a significant change in your financial status.

Such monitoring ensures that you steadily move towards attainment of your financial goals and targets over the short and the long term.

CONCLUSION

Do you want to prepare your Financial Investment Plan (FIP)?

If yes, contact Charity immediately on charity@parexcellence.co.ke and start your journey towards financial independence.