There’s been a proliferation of easy loan products and use of digital credit as mobile money transfer services become widespread.
Unlike traditional lenders that have stringent conditions, mobile loan apps are instant, require zero paperwork and use alternative credit scoring models, such as mobile money transaction data, to determine eligibility for credit. What could be more convenient?
Statistics from these financing platforms show the appetite for loans runs into the hundreds of billions of shillings. Debt helps drive consumption and demand, which in turn drives economic growth and general social well-being.
However, debt also has unintended consequences. The cries of people who are deep in debt traps are becoming louder and louder, with disastrous effects on the socio-economic fabric of the country.
The first rule of thumb for borrowing is that you’re leveraging the results of your own capital to generate more revenue – the key phrase there is ‘your own capital’. The second rule of thumb is that the use of debt should generate enough cash inflows to cover the principal and cost of the debt. So, how can you avoid falling into a debt trap?
1. Plan your future obligations
An SME making sales may realise that the tender they won pays after 90 days. Having borrowed credit from suppliers for 30 days, the entrepreneur is forced to find money to pay creditors and continue running the business to meet demand for another 60 days. This is a recipe for disaster. Plan your future financial obligations to know how much to save or how much profit to retain.
2. Don’t fall for the fancy wording
What e-credit does is extend your purchasing power beyond your normal income level, with a promise that it’s free if you pay up on time. However, the reality is that you can’t pay it up because your income was never enough to afford it in the first place. Your income for the next month is reduced by the amount that has to pay for the credit, meaning you might have to borrow to cover that hole.
3. Create a solid financial plan
Track where your money goes to capture all your expenditure and identify areas of concern that are against your budget. Subsequently, create a repayment plan to help you get out of debt fast. Doing so not only helps you address your current predicament, but also creates a viable solution to your financial problems.
4. Prioritise your needs
Refrain from purchasing items that aren’t critical for survival, but instead just boost your comfort. Create a priority list to segregate your needs and avoid spending on non-essentials, or find cheaper alternatives.
The writer is the chief investment officer at Amana Capital.
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