Debt. It’s undeniably among the biggest causes of stress in society today. Even when times are normal and economies are running as expected, many people find themselves falling behind their loan repayments, initially just by a few days but once that happens, the risk of default rises. Defaulting is tricky because it tends to dry up that line of credit from future consideration. But more urgently, defaulting on the loan places a huge risk on the collateral you placed to guarantee your loan. You risk your loan provider actually auctioning that very property.
Many people have found themselves at the risk of debt default, especially after the novel Covid-19 struck havoc globally in early 2020. To respond to the virus, many governments, following World Health Organisation recommendations set up lockdowns requiring many people to stay at home and not go to work. This, unfortunately, meant that many people’s means of living, especially in the informal sector, was all of a sudden cut short.
For a country like Kenya, where more than half the population is dependent on informal earning streams, this was a major disaster in the making. Many Kenyans have found themselves out of work and facing debt default on a mass scale. In Kenya, when you default a loan from a registered financial institution and even micro-finance institutions, you are listed negatively with the Credit Reference Bureau. (CRB). Being listed negatively on this platform severely dents your credit score. A poor credit score indicates a lack of creditworthiness and makes it unlikely for you to qualify for future debt.
So what options do you have when you find yourself facing a debt trap disaster? What do you need to do to get out of chronic debt? How do you escape the debt trap in a stressed-out economy like Kenya?
1. Take time to assess your debt levels
You won’t’ find yourself debt trapped all of a sudden. Normally, at the start, you have several credit lines open to you and you find yourself utilizing more than one line of credit. As you start defaulting on one line of credit, you easily find yourself starting the habit of borrowing Peter to pay Paul, before this cycle catches up with you. Within time you find yourself staring at a web of intertwined debt with several debtors seeking their repayments simultaneously and yourself staring at simultaneous default and risk of auction. Most times, you are so busy borrowing and seeking repayments that you don’t even get to understand the scope of the hole you have dug yourself in. By the time you feel stuck, you are in so much trouble than you actually anticipated. That is why the first thing you need to do is understand just where you lie. It’s important for you to assess and record down all your debt into a single spreadsheet. This process is really straightforward. Write down all the loans you owe to everyone. How long it has been due, how much interest is due. If it is a bank loan, for instance, you should write down the whole remaining loan ( Principal + interest ) in a separate column vs what you have already defaulted in a different column. You want to have a big picture assessment of your debt. Depending on the complexities of your debt, you may want to seek the help of someone, preferably an accounting professional to help you with this assessment. Many times, for private debt, this may not be necessary since most personal debts tend to be very straightforward.
2. Seek Credit Counselling
When you find yourself stuck in a debt trap, you may become confused and lack any idea about what to do. You may reckon that you have limited options and are embarrassed to let even those closest to you be aware of your financial problems. Thus you find yourself trying to figure out on your own how to escape this cycle of debt which only leads to insurmountable stress. Within your circle of friends and family, there is always one person you know who may have an understanding of how to navigate your debt issues. Find yourself, someone, you can trust among your close friends or family who you can talk to about your debt problems. Preferably, you will want someone who will not judge you but rather understand you and try to face your problems while walking in your shoes. In the unlikely event, you do not have someone you feel is well qualified to engage you, or if you simply feel ashamed to do so, then you may want to seek an outsider professional to guide you. Some professionals may charge you and thus it is important to get one who will help you without charging you so expensively that you find yourself in further financial trouble.
3. Stop digging ( if you can)
If your aim is to get out of a hole, then digging yourself deeper may not help much. Similarly, if you find yourself in a debt hole, stop piling more debt. This is easier said than done. In many instances, people who are heavily indebted find that the only way to survive is to accumulate more debt. The trouble is that by this time, you normally have an even worse credit score thus you land even more expensive credit lines. This is because you present a higher risk of default to the lender and thus to protect their risk, they are forced to charge you a higher interest rate. Thus the first thing you need to take into consideration is that, if you really can help it, STOP ACCUMULATING MORE DEBT!
4. Prioritize your debt repayments
After the first step of assessing your debt levels, the next obvious step of course is to see if you can take care of these debts and in which order you should do so. When you get some income, it is important to prioritize debt repayments, especially ahead of non-investment-related recurrent expenses. Meanwhile, as regard debt repayments, it is important to start with the more expensive debt ( that debt that accrues higher interest rates). Credit Card debts, as well as debts from Micro Finance Institutions, tend to, in general fall into this category and hence should be prioritized. In fact, it is a good habit to ensure that the most expensive loans are as short-term as possible. The longer you stay with expensive loans, the more the loans become a burden to you in the long run.
5. Restructure the overburdening loans if you can
Sometimes, when unexpected occurrences happen, like Covid 19, slowing down business or causing job losses, you can easily find your income prospects negatively affected. As a result, you become unable to meet your expected debt obligations.
At this juncture, it is wise to approach your lender and request a loan restructuring. Restructuring normally involves stretching the repayment period so as to reduce the monthly payments.
As mentioned in elsewhere in this article, this has the unfortunate overall effect of making you pay more in the long run. But while this may be the case, it is still a good thing to consider given the fact that it helps you avoid defaulting by reducing your monthly payments.
The restructuring may also involve negotiating a payment holiday for a brief period. However, you should note that even when you do this, the interest rates keep accumulating during this period, and thus you should not use this unless you really have to. Once you get back to your feet, even when you have negotiated for a longer period of restricted time, you should consider paying more so as to finish earlier.
6. Negotiate your loans wisely, renegotiate if possible
There are very important facets of loans you should be very careful about during negotiation. One of them is interest rates. Normally there are two types, flat rate, and reduced rate. At face value, flat rates normally look lower than the reducing rates but they can be very misleading. That is because, for flat rates, the interest rate is paid on the original principal throughout the period while reducing rates charge interest on the remaining balance after partial payment of the loans.
For instance,
Consider a loan of Kshs 10,000 to be paid at a flat rate of 10% per month and taken over 2 months.
For a flat interest rate basis, the first month the loan shall accumulate interest of Kes 1,000 (10% of Kes 10,000) and the second month the interest shall also be Kes 1,000 ( 10% of Kes10,000) totalling Kes 2,000.
.Thus the loan to be repaid is Kes 10,000 ( the principle) + Kes 2,000 ( the interest)
The monthly repayment is calculated as follows:
Principle + Interest = Kes 12,000
No. of months 2
This shall lead to a monthly repayment of only Kes 6,000 /=
But consider the same loan amount, at the same interest rate for the same period ( 2 months) but now on a reducing balance basis.
At the end of the first month, the interest due shall be 10% of the whole amount. i.e Kes 1,000.
Assuming you pay half the principal plus the interest, e.g Kes 5000 + Kes 1000 = Kes 6,000
The remaining unpaid principal is Kes 5000. This shall be the amount upon which you shall be charged interest of 10% amounting to Kes 500.
Now the amount due to clear the loan would be Kes 5,500.
If you total the amount plus interest for both months, it comes to Kes 6,000 + Kes 5,500 which is Kes 11,500. This is Kes 500 less than the kes 12,000 that would have been paid under flat rate. Thus it is clear that all other factors held constant, reducing balance is definitely more preferable to a fixed rate.
This fact is important when negotiating or accepting your loans. Some loans look deceptively cheap but are actually a very dear affair. It is important to understand fully what you are getting into.
7. Consolidate if it makes sense to
Sometimes it is very stressful when you have many loans from many different sources all having differing maturing timelines. Upon assessment, it may be a good idea to consider consolidating your loans.
Among all your loan options, you may seek one that seems easier to deal with in terms of the cost of the loan as well as repayment terms. If such a provider has the capacity to buy off the rest of your loans, or offer you an amount that can enable you to offset other loans, you may find this option being an advisable one to consider.
8. Increase your income streams
The real solution to dealing with your debt trap is improving your income streams. Whether it is achieving more revenue from the single-channel you have now, or diversifying to get more income, more revenue is the ceratin way to free yourself from debt.
The additional revenue generated should be prioritised to clearing your debt levels. While it is not possible that you shall always be 100% debt-free, it is best to make sure that your levels of debt are sustainable and allows you to borrow more should you face an emergency in future. It is also important to improve your credit score by consistently keeping your word in terms of repayment of debt.
9. Set up a budget going forward and stick to it
Finally, even if you doubled or tripled your income unless you build a discipline of living well within or below your means, you shall consistently find yourself riddled in debt.
The first way to keep such discipline is to come up with a very well thought out budget that fits your income, inclusive of provisions for savings if possible, and stick to it. Make sure that you review your budget very often.
One of the ways to ensure that you stick to your budget is to install an active daily expense tracker. If you are looking for a sample free expense tracker, this one from the Google Play Store may be worth checking out::
https://play.google.com/store/apps/details?id=com.expensemanager
10. In summary
Debt is not necessarily a bad thing. It can positively help us to grow. But if abused, or if circumstances drastically change, debt can be very straining almost to a level of feeling as if you are in a debt trap. How do you escape this debt trap? What can you do to manage your debt better?
These nine ways are the trick:
- Assess: Take time to assess your debt levels
- Counsel: Seek Credit Counselling
- Stop: Stop digging ( if you can)
- Prioritize: Prioritize your debt repayments
- Restructure: Restructure the overburdening loans if you can
- Negotiate: Negotiate your loans wisely, renegotiate if possible
- Consolidate: Consolidate if it makes sense to
- Income: Increase your income streams
- List Item
- Budget: Set up a budget going forward and stick to it
Definations:
Default: [efault is described as the inability to honour to make a financial repayment obligation. Normally, default is not assumed on the exact same day that the debt is due. Normally, default is assumed after some brief period after the debt is due.
Collateral: Collateral is the asset that you normally would sign up with your financial institution to guarantee your loan. The financial institution has a legal right to sell off the asset to recover your loan plus your interest should you be unable to repay.]
