Short-term or unsecured loans can be a red flag to home loan providers when featuring strongly in a potential home buyer’s financial history.
This may be the case even while they are keeping up with repayments, says Renier Kriek, Managing Director at alternative home finance business, Sentinel Homes.
While all debt should be managed responsibly to maintain a good credit score, for many South Africans, short-term loans have become a way for citizens to make ends meet, or to fund luxuries they cannot afford but refuse to live without.
Credit providers use various risk models to identify patterns in potential customers’ spending behaviour-good and bad. They know what financially responsible and irresponsible spending patterns look like.
“Frequent short-term loans-with or without defaulting-are a risky pattern that implies an individual does not manage debt well, and that is something a home loan provider does not want to make a long-term investment in.
“The ability to delay gratification is the underlying attribute that responsible users of credit have, but there is no easy way to quantify whether a particular applicant possesses that trait – the number, frequency and type of unsecured credit transactions is a useful proxy in that regard.”
Kriek said the right course of action, especially to those who already have short-term loans is to first, understand that short-term loans have their place but are seldom necessary. He urged these customers to stop using them and make a plan to pay off the ones they already have. Then they should get to work on building an emergency fund of cash that can only be touched for true emergencies, so that they will not need unsecured debt in those cases, he said.
Secondly, he advised aspirant homeowners to work on saving for luxuries such as holidays and large capital purchases. He said they will be paying monthly anyway, whether they take the credit or save, but in the saving scenario, interest will be working in their favour rather than against them. He added that delaying the gratification of that large purchase is difficult, but no-one said adulting would be easy.
Finally, Kriek said if there is no other option, they must opt for “good” debt as far as possible. He said they should buy their clothes, furniture, appliances, groceries and other items using store credit if they absolutely cannot do without. He said they do not have to buy things they do not need to build a good credit score as everyday items and normal household purchases are fine.
“Credit providers’ risk algorithms generally look favourably on consumers who start their credit journey with store debt because it fits the pattern of responsible spending, provided you pay your accounts on time, of course, and do not spend near or above your credit limit,” Kriek said.
Kriek said that eventually, most people end up before a home loan provider in the hope of buying a house they love. He said that lenders are profit makers and risk reducers, so it was important to think like they do.
Earlier this year, FNB Home and Structured Lending told this publication that 20% of home finance applications received in the previous year were approved and registered with FNB.
Are you a good investment? Will you repay your home loan on time and in full? The lender’s modern analytical systems – often powered now by artificial intelligence – evolved to answer questions like these and exist to protect their owner from risk.
“Short-term loans that literally fund your lifestyle can easily sway the algorithm against you, especially if you are funding luxuries or nice-to-haves from easy debt rather than developing the discipline of saving.”
Rebuilding a damaged credit profile can take years and often requires a focused change in financial behaviour and including some sacrifice, said Lynette de Beer, Interim Chief Executive Officer at the National Credit Regulator (NCR).
To avoid these pitfalls, young people need to develop financial discipline and literacy early in life. This includes understanding how credit works, budgeting, saving, and delaying gratification, De Beer advised.
The NCR said one of the most concerning aspects of this trend is that many young people were able to access credit without a reliable or consistent source of income. It said this was whether they are students, part-time workers or unemployed, their financial situation often does not match the financial obligations they were taking on. Without a stable income, repaying loans becomes difficult and missed payments lead to mounting interest, penalties and ultimately, bad credit records, the regulator said.
De Beer warned that what may seem like small loans can quickly spiral into a bad credit profile, reduce employment opportunities but also limit future credit access.
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