Never been costlier to take loans

On June 25 the minister of trade and industry published draft regulations in terms of the National Credit Act, which, if adopted, will cause the costs of small credit (typically money loans), which are already excessive, to become exorbitant.

If implemented, these new costs will have a devastating effect on low-income consumers, and increasing amounts of money will be drained out the hands of the poorest merely to service debt – this at a time when government claims that poverty alleviation is a national priority.

The Act and the national credit regulations, fully implemented in 2007, set new limits on interest rates, but introduced new fees.

The combined effect of interest, the initiation fee and the service fee has caused the total cost of small credit (short-term credit transactions) to remain excessive, as illustrated in the table above.

A “short-term credit transaction” is one that does not exceed R8 000 and is repayable within six months.

It is assumed for the purposes of the calculations in this table that:

• The total initiation fee is charged to the borrower and capitalised, that is, paid off over the same period as the loan, at the same interest rate – 5% a month in the case of a short-term loan; and
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• Interest is charged only on the loan amount, for the purposes of simplicity. The regulations allow interest to be charged on unpaid interest and other fees, which would make the total cost of credit even more expensive.

All figures in this table are rounded off to the nearest rand or percentage point. The current initiation fee is R150 a month, subject to a maximum of 15%.

The monthly instalment is calculated by applying the formula FV = PV(1+it) (FV = future value; PV = present value; i = interest rate; t = time).

The service fee is a flat rate of R50 a month, expressed as a percentage of the initial loan.

The monthly combined cost of interest, the initiation fee and the service fee is expressed in rands and as a percentage of the initial loan.

It is clear from this table that: The smaller the credit, the more expensive it is;

• The effect of the capping of interest rates on credit between R1 000 and R500 is minimal, and there has been a negative effect on loans of R500 and less;
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• The positive effect of capped interest rates has, to a large extent, been negated by the high maximum initiation and service fees;
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• The effect of the initiation and service fees on smaller loans amounts to a skewing of the cost of credit away from interest and towards these fees, so that interest decreases relative to these fees;
• This skewing has the dangerous effect of masking the true cost of credit to the consumer, and inhibits the Act’s objectives of promoting disclosure and combating over-indebtedness.
• Limit interest rates
The draft regulations have done little to alleviate the situation, but if implemented will exacerbate the hardship and overindebtedness of consumers of small credit.

It is proposed that interest rates on second or subsequent small credit agreements in the same calendar year be limited to 3% a month, but interest on the first small credit agreement in every calendar year (the vast majority of credit agreements) will remain at 5%.

The initiation fee
It is proposed that the maximum initiation fee be increased from R150 to R165, which will further burden the consumer.

In addition, it is proposed that the limitation of the initiation fee to 15% of the principal debt be scrapped.  Whereas currently the maximum initiation fee changes relative to the size of small credit of less than R1 000, this will no longer be the case.
No matter how small the loan (even a loan of R200) this amendment allows an initiation fee of R165 to be charged.

The initiation fee, whose purpose is not explained anywhere in the legislation, already adds considerably to the cost of credit.

It is often impossible for consumers to find the necessary cash to pay the initiation fee up front at a time when they are borrowing money precisely because they are in need of cash.

Thus invariably the initiation fee is capitalised and added to the loan amount, attracting its own credit costs.

This amendment is inexplicable, and will cause untold additional hardship and overindebtedness to a consumer community that is already in crisis.

There appears to be no rational basis for it, especially given that overindebtedness is widely accepted to be a serious socioeconomic concern in South Africa today.

The service fee
Further, it is proposed that the maximum monthly flat rate service fee be increased from R50 to R60, which will add an additional financial burden to the consumer.

Thus, 12% of an initial loan amount of R500 (currently 10%) will be charged each month merely to service the debt.

Like the proposed initiation fee, the maximum service fee is not varied according to the size of the credit.  This result conflicts with the intention of the Act, which provides that the initiation and service fees “must not exceed the prescribed amount relative to the principal debt”.

That is to say, it should be higher for bigger loans, and lower for smaller loans. This purpose is not borne out in regulation 44, which may therefore be ultra vires and should be amended.

The result of the proposed amendments is that the cost of small credit, which is already excessive, will become unconscionably exorbitant.

The proposed regulations achieve the exact opposite of the imperative on the minister of trade and industry to consider, inter alia, the social effect on low-income consumers.

Legislated abuse
By allowing the costs of small credit to remain so high, the government has in effect made possible the exploitation of lower-income communities, which arguably amounts to legislated economic abuse.

The proposed amendments will ensure that these trends continue and are exacerbated and that they will contribute to the perpetuation of poverty.

Not only should these amendments not be adopted, but the current regulations require urgent amendment in order to address these shortcomings and help to alleviate the burden of debt of the poorest and most desperate South Africans:

• The initiation fee should be removed if its purpose cannot be satisfactorily justified. Alternatively, the maximum initiation fee should be considerably reduced to R50 per credit agreement, plus 5% of the amount in excess of R1 000, but never to exceed R1 000, and never to exceed 5% of the total principal debt.
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• The monthly service fee on smaller short-term credit should be removed, and interest could be increased in turn to compensate for this. Alternatively, the maximum service fee should be considerably reduced to about 1% a month of the credit amount, subject to a minimum fee of R10 a month, and never to exceed R50 a month;
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• The maximum permissible rate of interest on short-term credit should be reduced to 4% a month; and
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• The maximum size of short-term credit should be reduced to R5 000.

When these suggested amendments are applied to the examples in the table above, they appear to address adequately the shortfalls in the regulations and to achieve a fairer result with regard to the need to balance the interests of both credit providers and consumers.

Jonathan Campbell is an associate professor and acting director at Rhodes University Law Clinic