Every now and then I meet people howling about their debt burden and how it’s making life difficult for them. Some of the loans are consumer loans used to buy a car, finance a pet project or even pay for house rent. I have always believed that your loan repayment per month should never be more than 40% of your salary or monthly income.
Anything more than that sets you on the path of financial crisis as the risk of default is mostly higher. But how then does one get out of financial crisis related to the burden of loans? I will attempt to give tips. As usual we will depict a real life situation for better guidance.
Example: Wale decided it was time to take a loan since landing his new job in 2016. He borrows N2.6m to buy a tokumbo car and the balance to pay for a new 3 bedroom apartment he just moved to. He earns a take home salary of N200k a month and currently pays N80k to the bank as loan. He also spends on average N80k monthly in living expenses such as feeding, transportation, wardrobe, entertainment etc. leaving him with N40k as savings.
Suddenly his company faces a financial situation and decide to slash salaries and cut staff strength. Fortunately or unfortunately Wale is not sacked but told to take a pay cut of N60k dropping his monthly take home pay to N140. He suddenly finds himself in deep financial waters as his loan repayment is now more than half his take home pay.
He currently owes the bank N1.3m (excluding future interest) after paying back half of the loan which was about N3.8b (including principal of N2.6m and interest). Since taking his pay cut in November 2018 he has defaulted twice in repaying his loan as his expenses almost doubled after getting married. The banks have written him severally and have now decided to act. What should Wale do?
Step 1: Don’t be afraid and never get depressed.
Step 2. Ask yourself honest questions
Step 3. How much can I possibly pay the bank now?
Now that you have decided how much you can afford to pay the bank, the next step is to determine what that means in the overall context of the loan. If you owe N1.3m and you wish to repay N40k monthly at an interest rate of 20% then the no of years you are looking to complete the loan will now be 4 years or 47months.
What this essentially means is that the loan which was to last 4 years will now extend to 6years. Remember Wale had paid for 2 year and had 2 left and to accommodate his N40k repayment, he needs to add two more years. This move whilst a cash flow relief will bring additional interest cost almost 100% of the loan value at the end of the payment.
You could also decide to adopt a progressive repayment rather than a uniform one. That is pay N40k for the first year and N60k the next and N80k till the loan is liquidated. This method does the twin job of giving you temporal relief while anticipating an improved cash flow and also helping contain the high interest cost associated with longer tenors.
Step 5: Approach your bank
Never get shy about telling your bankers your financial predicaments. Remember your success/failures is directly proportionate to theirs so its always in their best interest when you show intent to repay their loans. Set up a meeting with them at a place of your convenience, make sure its a discussion over lunch or drinks as that creates a friendly environment.
Tell them your plans in the clearest form and give an impression its a honest and well thought out now. Make them understand its a win win situation and actually benefits the bank more as they get more cash flow. Don’t be ashamed to tell them you just got a pay cut and as such don’t have a choice but to do this.
Even if you never had a pay cut but just have financial constraints, make them understand what your predicaments are and how a restructuring of the loan is the best option. They may come with their own proposals for a way out which may or may not be better than yours. Whatever the case just remember than your guiding principle is the cash available to you after you debt service.
Step 6: Forward an official letter to the bank:
After you must have concluded negotiations with your account officers, you should now write them officially requesting for a restructuring of the loan. The tone of the letter can look like this. The response time for banks typically varies depending on the efficiency of their operations. Based on that, it is often advisable that you follow up from time to time especially via emails. Emails are good record keepers as such is mostly preferred as a communication took.
Step 7: Post Restructuring
Once your offer has been approved, the bank will give you a restructured facility with terms and conditions. Make all efforts to read the fine prints as banks notoriously embed details in it. Ensure you look out for the following
- Tenor – Make sure it’s the number of years/months you agreed with the bank.
- Interest Rate – Always check interest rates especially if they are tied to benchmarks. Sometimes they tell you it’s “subject to market conditions” or “MPR plus 12%”. Whatever the case, they are simply telling you interest rates can go up (hardly down). Make sure your offer rates are competitive. To make sure, consult your accountant or friends in other banks.
- Fees – Fees are often over looked when it comes to loans, whereas they are also a cost. When you are restructuring, the banks typically will charge you a “restructuring fee”, “management fee” and facility fee”. Restructuring Fee is a one off payment and can range from 0.25% to 1% of the loan. Always negotiate for 0.25% or even zero. It is possible if you make them understand you can’t afford it. Management Fees are paid every year and is a flat percentage of the outstanding principal. They can tell you it is 1% of the Loan or 0.5%. Facility Fee is also similar to the restructuring fee. However, this is mostly charged for a new loan. Whatever the case strive for a total Fee that will NOT cost you more than 0.5% per annum.
- Security – Make sure the security (collateral) they are asking for is what you agreed with them during negotiations.
- Caveats – There are usually loads of clauses and caveats that are found under “Other Conditions”. It can be burdensome to read but since its your but on the line, I suggest you read them. Particularly the clause that refers to early repayment. Some banks charge you if you decide to repay all or part of the loan before it is due. Make sure this clause says “you will not be charged for early repayment of all or part of the facility”. Who know, you might land a lucrative job and decide to pay off the loan.
Step 8: Endorse the new offer
Sign a copy of the offer and keep an original as well (with the signature of the representatives of the bank).
Step 9: Think about another job
Start to look for another job or find a way to improve your financial situation. Even with the relatively affordable cash payment Wale has to make, he still has less disposable income available to him. As such a debt burden is something he needs to get out of his life. That will only be put to bed by an improved stream of cash flow.
Conclusion – Whilst these are basic steps to guide you, it is advisable that you consult Accountants, Lawyers when negotiating with a bank. Never be afraid to negotiate your way out of the pains of debt. Be smart and think rich.