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The decision to take debt for many people is based on whether or not they can afford the monthly repayment. The amount of debt taken and interest cost over time are only secondary considerations, if at all. Many people reading this article today have been in debt, are in debt or considering taking some form of debt. You might then relate to considering debt only in terms of whether or not you can afford the monthly repayment.

Let’s look at the flaws of this type of thinking. Firstly the opportunity cost of the interest paid is not taken into consideration. Say you borrow Kes 500,000 for 5 years. You monthly repayment on this loan will be only Kes 14,000 which may not look like a lot and this is the figure that most people use to determine whether or not they will take the loan. However over time the Kes 500,000 will be paid back to the bank but you will pay an additional Kes 380,000 in interest (at current rates). So in actual sense you will pay back the bank Kes 880,000 over the five years. This is the figure (Kes 880,000) you need to use to determine whether or not you really need that loan and not Kes 14,000 per month. Say you bought a car with this money. The value of the car in 5 years will be much lower than Kes 500,000 yet you have paid Kes 880,000. If you can afford to repay the bank Kes 880,000 in 5 years it also means you can also afford to save and invest that same amount of money. The growth in value would be significantly more and you could buy a car debt free and still have money left over to continue investing.

Secondly by only using the repayment we tend to base our borrowing decisions on income. An increase in income means an increase in borrowing because you can afford yet another monthly repayment. A Kes 20,000 increase in net salary is mostly seen as way to buy something consumable (car, furniture, TV, Holiday etc) that will cost 20,000 in a monthly repayment but at the end of the day, it will be worth much less than what was spent on it. When this cycle goes on continuously, it becomes the reason why people cannot afford to retire or sustain themselves in the event of job losses. When planning money it is important to always look at the overall picture and just not the monthly impact because bad borrowing decisions will always have consequences in the future.

Debt is not bad, but the way we use it and think about it gets us in problems. If you do decide to borrow please ensure you are aware of what it will actually cost you to borrow. Ask your bank how much in TOTAL you will pay in interest over the period, not just what the monthly repayment is. If you do have to get the loan look for ways of minimizing interest costs such a saving for a part of it and then borrowing the rest or putting in additional repayments during the course of the loan.

Waceke Nduati- Omanga

The author teaches personal financial management. Find her at www.centonomy.com

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