BY WACEKE NDUATI-OMANGA
I met James* at a training we facilitated last week. James took a mortgage of Sh10 million five years ago to buy his home.
James expected that after five years of making consistent monthly payments of approximately Sh140,000 without defaulting, he would be pleasantly surprised to find out how much he had actually paid down. He told me he was horrified to find that his outstanding loan balance after five years was still Sh9.5 million; he had only paid down Sh500,000 towards his loan!
This prompted him to go through his finance records; James found that in those five years, he had paid out a total of Sh8.3 million. This is almost the cost of the house he was buying. However, only Sh500,000 had gone towards actually reducing his loan. The rest, i.e. Sh7.8 million, was interest to the bank. Money that carried no benefit for him.
At this point if you have any loan, I suggest you do what James did and immediately call your bank to find out what you still owe them. You just might be a bit surprised that in spite of your regular monthly repayments your loan balance has not decreased by much.
James, like many of us, did not understand how loans work. He is being charged 16 per cent in interest every year. 16 per cent of Sh10 million is Sh1.6 million a year. If we average this out into a monthly rate it would come to about Sh133,000 per month. This means a large portion of his payment is going towards interest and not necessarily cutting back on the loan.
James found out that when he started paying his mortgage, only about Sh6,000 per month was going towards cutting back on his loan and the remainder was servicing interest.
DEFINITION OF BAD DEBT
Had James not realised this and continued paying his loan as is for the remainder of his mortgage, he would have paid Sh23.4 million in interest charges alone. This is in addition to the Sh10 million he initially borrowed otherwise known as the principal. His house would have effectively cost him Sh33.4 million and not Sh10 million.