As we continue with last week’s column, the decision to take up a loan should be backed by thorough due diligence, and the economic returns should outweigh the total loan cost. Many businesses, as we know, rely to a lesser extent on borrowing funds. The selection and the management of debt are fundamental aspects of the management of any business and their impact on the business cash flow.
One of the things stated last week to consider was the total cost of the loan, so we now need to do an in-depth elaboration thereof. In most cases, interest charges are the most significant cost on loans; however, other costs may be equally as important.
It is imperative to also understand that interest can be calculated in various ways, and this has an impact on the true total cost of the loan.
What do we mean by interest on a loan?
Interest is the additional money you have to pay to the financial institution that lends you the money, which we refer to as the main cost of credit.
Interest is conveyed as a percentage of the total loan amount you have/intend to borrow. Usually, the interest is calculated on a monthly or annual basis of the total loan amount. Depending on the loan structure, you may be required to pay interest yearly, monthly or weekly.
There is a huge difference between an interest rate charged on a weekly, monthly and yearly basis – and consequently the total cost of the loan.
Thus, it is imperative that you fully understand the loan structure, the requirements, and the full total cost.
You also have to ask your lender to provide you with an illustration of different loan outcomes based on different variables, such as the repayment period, the instalments, and the collateral as all this at different intervals will give you a different outcome on the total cost of the loan.
Additionally, besides the interest fee, there may be extra costs of credit, such as administrative fees, charges, loan processing fees, insurance, legal fees, stamp duty and penalties.
This will help you decide whether you can afford the full total costs, and using the comparison between different offerings from different lenders you may come to a different conclusion altogether.
Remember: “It’s easy to get into debt but hard to get out, if you are already struggling with debt, avoid taking another loan. Do not dig a hole to fill up another hole”.
Additionally, do not fear debt; ensure you understand absolutely everything about the loan options and let your money work for you.
Again, the loan should be taken for income-generating and productive investments only.