Reckless borrowing can cause serious financial problems which can affect your future ability to get a job, buy a home, or obtain any new credit at a reasonable rate. There are two different types of loans generally offered to consumers: secured and unsecured. A secured loan is a loan which requires some form of collateral from the borrower. For example, this could be your home or your car. An unsecured loan does not require any type of collateral and therefore carries a greater risk for the lender.
There are various issues that a person or business is required to consider before committing yourself to either secured or unsecured loans.
Can I afford to repay the loan?
If you have doubts about your ability to repay the loan, do not sign the loan agreement. Don’t depend on possible salary increases or bonuses to help make the payments more manageable. If you cannot depend on your current financial situation to repay the loan, do not proceed any further.
What are the terms and conditions of the loan?
It is your responsibility to read and review all of the terms and conditions of your loan agreement. Lenders are required by law to disclose to you all of the terms and conditions of your loan in writing before asking you to formally sign the loan contract. Do not sign a contract which contains any blank spaces. If you have any questions or concerns, ask your lender before signing the loan papers.
Am I dealing with a reputable company?
Most lenders are reputable but unfortunately there are some unscrupulous ones doing business also. Take the time to research different companies before choosing one to work with. Contact your financial advisor to see if there are any complaints or lawsuits lodged against a specific lender.
Am I borrowing money for something I really need?
Many people have trouble differentiating between a “want” and a “need”. Whenever you decide to take on new debt, be certain that it is for something you “need” and not just an impulsive “want”. Give yourself plenty of time before making a final decision. More often than not, something you think you need seems less important after a week or so of consideration.
After considering these issues there is need for you to make a decision either to go for secured borrowing or unsecured borrowing. Before making this decision you need to know the advantages and disadvantages of each of the method, i.e. secured or unsecured lending. In the section below I outline some of the advantages and disadvantages of secured loans. The following are some advantages of secured loans:
Your interest rate will generally be lower and more affordable than with an unsecured loan.
Payments are normally spread out over a longer period of time giving you more flexibility with repayment of the loan.
You can usually borrow larger amounts of money compared to an unsecured loan.
You may be able to get a secured loan with a less-than-perfect credit history. Since you have to provide collateral for a secured loan, lenders will be assured that they will get their money back even if you default on the loan.
The following are some of the disadvantages of secured loans are:
You are required to pledge specific assets as collateral for the loan.
If you are unable to make the regular payments and/or default on the loan, the lender has the right to repossess your pledged assets to recover the money which is owed.
Repayment periods are generally longer than with an unsecured loan meaning you are in debt for a longer time.
Banks when continuously faced with the default problem, they may continue to lend out on the basis that the client offers adequate collateral. This is one of the major reasons for banks demanding that a borrower pledges collateral which the bank can dispose when the borrower defaults. Under this arrangement the bank has a legitimate expectation to get the money back or else they will put the pledged collateral under the hammer and the financial intermediation process will continue.
This is the direction that banks in Zimbabwe are likely to be taken moving forward because the amounts of defaults have been rising since the adoption of the multi-currency system in 2009. Non-performing loans were less than 2 percent in 2009 but these had increased to 18,5 percent in June 2014. This means that on average of every $100 that banks have been advancing to businesses and individuals, US$18,50 is not being repaid by the borrower.
This then leads to the problem of disintermediation where those who genuinely need resources cannot access them from the banks.
To circumvent this problem, banks are forced to ask for collateral so that they have a fall back in case the lender defaults.
Sanderson Abel is an economist. He writes in his capacity as Senior Economist for the Bankers’ Association of Zimbabwe. For your valuable feedback and comments related to this article, he can be contacted on [email protected] <mailto:[email protected]> or on numbers 04-744686 and 0772463008