How to compare two loans
The Sunday Nation
Nairobi,
18 July 2010
After last week’s article comparing a loan taken in one lump sum to
another taken in instalments, several readers have disputed the
conclusion that the latter is cheaper than the former. Perhaps the
dispute arises because it did not come out forcefully enough that the
monthly portions were to be taken for one year while the lump sum is
kept for only six months.
The two situations that our reader, Job Mwangi, was wondering about
were: taking a million shillings every month for one year or taking Sh12
million at once and keeping it for six months. This problem brings out
the critical factors to be considered when borrowing money from a bank,
namely, the interest rate and the duration of the loan.
If the two durations are the same, then collecting the loan in
instalments will work cheaper than taking a lump sum. Thus if Mwangi was
to take six-month loan in, say, six instalments of two million shillings
each, the total balance payable would be Sh12,536,075.
Now if you
recall last week’s results, taking a lump sum for six months gives a
balance of Sh12,301,875.
Therefore, an six-month instalment plan would be Sh392,523 cheaper than
the lump sum.
Sounds confusing? Let’s try and establish some simple basic rules.
First: when comparing two borrowing plans, hold one of the factors
constant. In this case we held the interest rate at 15 per cent per
annum. Second: a lump sum loan kept for a certain duration is more
expensive than one taken in instalments over the SAME period.
With these simple rules, we are able to answer a question asked by Peter
Mburu: Which is cheaper; a one million shilling 5-year term loan at 18
per cent interest or an overdraft facility of similar amount over the
same period at the same rate?
The answer is quite simple now: the overdraft will be cheaper.
Unfortunately, we cannot give more specifics of the repayments because
we don’t know how much Mburu will be withdrawing every month. The
convenience of the overdraft is that you can draw out different amounts
at any time as your needs demand. However, you have to watch your
balances very carefully to ensure that you never borrow when you don’t
need the money.
The moral of this story is this: don’t rush to take a loan just because
a bank is offering “low interest rates”, think carefully about your
re-payment plan and use the one that works cheapest.
*************
I have been trying to avoid this question for some weeks now, but people
continue to ask it: is there enough time to register all the 20 million
SIM cards in the country? This matter was ably tackled by fellow
columnist Clay Muganda in his
Daily Nation series “
In short; the answer is YES. First of all, most subscribers had already
registered their details when they signed up for the popular mobile
money transfer services. Secondly, the telephone operators are using
their cash agents as registration centres and there are more than enough
of them.
So, don just sit and wonder whether there is enough time: get out and
have yours registered!
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