loans
Loans You will encounter loans later on in more detail when you look at the mathematics behind the calculation of interest (Simple and Compound interest), and also how to calculate the repayments of loans (Hire purchase and instalments). For now we will only take a look at the various ways in which people can get access to loans, without looking at the calculations behind them. 1)
Micro Loans Micro financing started in the 1970’s when financial services were offered to poorer people. The repayments on these micro loans were much higher than what the Banks would charge, but people who could not come right with Banks were in a better position to loan money here. Any institution that lends money to people will only do so if they know that they can get their money back. Banks will typically ask for some kind of guarantee (that is why there is a saying that Banks will lend you money if you can prove that you don’t need it!) and micro lenders used to keep people’s ID-books and bank cards, so that they could draw the money as soon as the person’s salary has been paid in. The period over which micro loans are being paid back is usually much shorter than with Banks as well – usually six months to a year, with interest that is calculated weekly or monthly, rather than yearly, and has to be paid back as such. Although micro lenders charge interest at a rate of between 30% and 70% (sometimes this rate is per month – not even per Financial Mathematics
year!) so that they can cover their risk, their instalments are still sometimes lower than with Banks, because the lending amounts are much smaller than what Banks will do. This is a very important point to take notice of: with Banks people might borrow amounts in the region of R100 000, while micro lenders will only lend R1 000. The money that is borrowed from micro lenders are usually for emergencies, such as to buy food, while the money loaned from the Bank is typically used for buying cars or houses. Although the interest rate with microloans are then so much higher than what is charged by Banks, the repayments are lower, and it is also quicker to pay off. It remains, however, a huge risk to the consumer, as a result of the high interest rate, and this is why micro lenders are sometimes referred to as “Loan Sharks”, because they could keep people “captured” in this cycle of Loan-and-Pay-Back for years. A consumer can get caught in the cycle of lending every month, just to be able to live and pay back previous loans, for a very long time, as a result of the high repayment rates (how much, in money value, it costs to borrow money).
Amount Interest rate Period Monthly repayment Total amount repaid Percentage more than the original amount loaned
Micro loan R500 30% per month 6 months R189,20 R1 135,20
Bank loan R500 9% per month 10 years R6,33 R759,60
127%
52%
Financial Mathematics
Micro loans are much more expensive than Bank loans, but Banks don’t lend such small amounts. If it was possible, however, the same client than now pays R189,20 to loan R500 from a micro lender, could’ve loaned about R1 100 from the Bank, for the same monthly repayment! Just shows how much difference the interest rates can make. 2)
Pyramid schemes A pyramid scheme is a non-sustainable model (this means it cannot last) that requires the joining of people other people to a network or chain, usually without a product or service associated to it. People will pay a regular amount, and this amount is distributed between the people higher up in the network, so that they get “money for nothing” each month, and the idea is that the people who came in last must also get people below them who are prepared to pay money on a regular basis, for the chance of getting people below them, and so on... The weak point of such a scheme is that there is no advantage for the person at the end: the money moves from person to person upwards and the creator of the network gets all the benefit. The people who came in last are disadvantaged the most, because at one point or another they will not be able to get new people in. The name “pyramid” comes from the fact that one person will usually develop such as system, and will then get, for example, three people to Financial Mathematics
enrol. Each of these three people will then get three people, and they will each get three people, and so on. This may not sound too bad, but if, for instance, you are coming in on the twentieth row, it would already take 1 162 261 467 people just to fill that one row, and the amount of people required to fill the pyramid up to that point is 1 743 392 200 (take note: almost two thousand million! This is considerably more people than living in the whole country). Where will you, and the people below you, get even more people to enrol? This is also why pyramid schemes are illegal, because people are paying for something that they might not get anything in return for. The earliest pyramid schemes were chain letters with a number of names and addresses indicated on it. The recipient of the letter then had to send an amount of money to the person on top of this list, and could then remove the name on top, add his or her name at the bottom, and repeat the process by sending out the letter to other people, and hope that the process would be repeated by those people.. Pyramid schemes these days are often camouflaged as Network Marketing, or Multi-level marketing, although it certainly does not imply that Network Marketing is illegal. It just happens at times that the focus is on the enrolment of new people, rather than the product itself. If the focus is more on enrolment and paying a registration fee, rather than using a decent product or service, you should be very careful. If run properly, however, Network Marketing is an ideal vehicle to get sales rolling, and lots of people could make good incomes, because they know that somewhere there will be an end to Financial Mathematics
people enrolling, but they will be consumers of a good product.. Network marketing meetings (where you are invited to) are usually characterized by: A sales pitch ( a very good presentation of the scheme) Little or no information about the company Vague promises about infinite income potential A tendency where early investors will talk about how high their incomes are 3)
Stokvels Stokvels are almost like clubs, where a number of people contribute to a common pool of money every month, and in general one person of this club gets an opportunity, during each rotation of members, to take that month’s contributions. There are many types of stokvels, which vary mainly on the rules of payouts, i.e. a specific type of stokvel will only pay money to a member when there is a medical crisis, or another may buy groceries on behalf of a member for a specific month.
4)
Credit unions The idea behind a credit union is actually very simple and brilliant, but it must be managed by someone with honesty and integrity, or else it will not be successful. How it works is as follows: A number of people pool a certain amount each month. One of these people then has the opportunity to loan this amount, and pay it back over a certain period, interest free. The following month everyone still put the Financial Mathematics
same amount into the pool, but now there is also the extra bit of the repayment of the loan. Somebody else, or more than one person, can now again borrow this money, and pay it back monthly. In this way there will be a little more each month, that is available for the members to borrow, and because it is an interest-free loan, it is much better than any other type of loan. As an illustration, let’s say ten people belong to the union, and each put R100 per month into the pool. There will then be R1 000 available in the first month, for someone to borrow. This person undertakes to pay it back over five months – therefore R200 per month. The next month there will again be R1 000 available, plus the R200, so R1 200. Now two people each borrow R600, and commit to pay it back over five months, at R120 per month. At the end of the next month there will now be R1 000, plus R200, plus two times R120 available, which equals R1 440, and which can be loaned by somebody else. After all the people had a chance to borrow a sum of money, the system can repeat itself all over again, and there might be even more money available this time around. The problem with such a system is that everyone must borrow regularly - if they don’t the pool doesn’t grow, but when you borrow money you must also be able to pay it back. A way around this is for someone whose turn it is to borrow to not spend the money, but actually use it to pay back the loan, if Financial Mathematics
they do not want to borrow at that time, or if they know they cannot afford the repayments. The management of this system, and how diligently each member pay the contribution, as well as the repayments, forms the basis for the success of such a credit union, and the person who manages it must be very credible.
Financial Mathematics
Micro Loans Micro financing started in the 1970’s when financial services were offered to poorer people. The repayments on these micro loans were much higher than what the Banks would charge, but people who could not come right with Banks were in a better position to loan money here. Any institution that lends money to people will only do so if they know that they can get their money back. Banks will typically ask for some kind of guarantee (that is why there is a saying that Banks will lend you money if you can prove that you don’t need it!) and micro lenders used to keep people’s ID-books and bank cards, so that they could draw the money as soon as the person’s salary has been paid in. The period over which micro loans are being paid back is usually much shorter than with Banks as well – usually six months to a year, with interest that is calculated weekly or monthly, rather than yearly, and has to be paid back as such. Although micro lenders charge interest at a rate of between 30% and 70% (sometimes this rate is per month – not even per Financial Mathematics
year!) so that they can cover their risk, their instalments are still sometimes lower than with Banks, because the lending amounts are much smaller than what Banks will do. This is a very important point to take notice of: with Banks people might borrow amounts in the region of R100 000, while micro lenders will only lend R1 000. The money that is borrowed from micro lenders are usually for emergencies, such as to buy food, while the money loaned from the Bank is typically used for buying cars or houses. Although the interest rate with microloans are then so much higher than what is charged by Banks, the repayments are lower, and it is also quicker to pay off. It remains, however, a huge risk to the consumer, as a result of the high interest rate, and this is why micro lenders are sometimes referred to as “Loan Sharks”, because they could keep people “captured” in this cycle of Loan-and-Pay-Back for years. A consumer can get caught in the cycle of lending every month, just to be able to live and pay back previous loans, for a very long time, as a result of the high repayment rates (how much, in money value, it costs to borrow money).
Amount Interest rate Period Monthly repayment Total amount repaid Percentage more than the original amount loaned
Micro loan R500 30% per month 6 months R189,20 R1 135,20
Bank loan R500 9% per month 10 years R6,33 R759,60
127%
52%
Financial Mathematics
Micro loans are much more expensive than Bank loans, but Banks don’t lend such small amounts. If it was possible, however, the same client than now pays R189,20 to loan R500 from a micro lender, could’ve loaned about R1 100 from the Bank, for the same monthly repayment! Just shows how much difference the interest rates can make. 2)
Pyramid schemes A pyramid scheme is a non-sustainable model (this means it cannot last) that requires the joining of people other people to a network or chain, usually without a product or service associated to it. People will pay a regular amount, and this amount is distributed between the people higher up in the network, so that they get “money for nothing” each month, and the idea is that the people who came in last must also get people below them who are prepared to pay money on a regular basis, for the chance of getting people below them, and so on... The weak point of such a scheme is that there is no advantage for the person at the end: the money moves from person to person upwards and the creator of the network gets all the benefit. The people who came in last are disadvantaged the most, because at one point or another they will not be able to get new people in. The name “pyramid” comes from the fact that one person will usually develop such as system, and will then get, for example, three people to Financial Mathematics
enrol. Each of these three people will then get three people, and they will each get three people, and so on. This may not sound too bad, but if, for instance, you are coming in on the twentieth row, it would already take 1 162 261 467 people just to fill that one row, and the amount of people required to fill the pyramid up to that point is 1 743 392 200 (take note: almost two thousand million! This is considerably more people than living in the whole country). Where will you, and the people below you, get even more people to enrol? This is also why pyramid schemes are illegal, because people are paying for something that they might not get anything in return for. The earliest pyramid schemes were chain letters with a number of names and addresses indicated on it. The recipient of the letter then had to send an amount of money to the person on top of this list, and could then remove the name on top, add his or her name at the bottom, and repeat the process by sending out the letter to other people, and hope that the process would be repeated by those people.. Pyramid schemes these days are often camouflaged as Network Marketing, or Multi-level marketing, although it certainly does not imply that Network Marketing is illegal. It just happens at times that the focus is on the enrolment of new people, rather than the product itself. If the focus is more on enrolment and paying a registration fee, rather than using a decent product or service, you should be very careful. If run properly, however, Network Marketing is an ideal vehicle to get sales rolling, and lots of people could make good incomes, because they know that somewhere there will be an end to Financial Mathematics
people enrolling, but they will be consumers of a good product.. Network marketing meetings (where you are invited to) are usually characterized by: A sales pitch ( a very good presentation of the scheme) Little or no information about the company Vague promises about infinite income potential A tendency where early investors will talk about how high their incomes are 3)
Stokvels Stokvels are almost like clubs, where a number of people contribute to a common pool of money every month, and in general one person of this club gets an opportunity, during each rotation of members, to take that month’s contributions. There are many types of stokvels, which vary mainly on the rules of payouts, i.e. a specific type of stokvel will only pay money to a member when there is a medical crisis, or another may buy groceries on behalf of a member for a specific month.
4)
Credit unions The idea behind a credit union is actually very simple and brilliant, but it must be managed by someone with honesty and integrity, or else it will not be successful. How it works is as follows: A number of people pool a certain amount each month. One of these people then has the opportunity to loan this amount, and pay it back over a certain period, interest free. The following month everyone still put the Financial Mathematics
same amount into the pool, but now there is also the extra bit of the repayment of the loan. Somebody else, or more than one person, can now again borrow this money, and pay it back monthly. In this way there will be a little more each month, that is available for the members to borrow, and because it is an interest-free loan, it is much better than any other type of loan. As an illustration, let’s say ten people belong to the union, and each put R100 per month into the pool. There will then be R1 000 available in the first month, for someone to borrow. This person undertakes to pay it back over five months – therefore R200 per month. The next month there will again be R1 000 available, plus the R200, so R1 200. Now two people each borrow R600, and commit to pay it back over five months, at R120 per month. At the end of the next month there will now be R1 000, plus R200, plus two times R120 available, which equals R1 440, and which can be loaned by somebody else. After all the people had a chance to borrow a sum of money, the system can repeat itself all over again, and there might be even more money available this time around. The problem with such a system is that everyone must borrow regularly - if they don’t the pool doesn’t grow, but when you borrow money you must also be able to pay it back. A way around this is for someone whose turn it is to borrow to not spend the money, but actually use it to pay back the loan, if Financial Mathematics
they do not want to borrow at that time, or if they know they cannot afford the repayments. The management of this system, and how diligently each member pay the contribution, as well as the repayments, forms the basis for the success of such a credit union, and the person who manages it must be very credible.
Financial Mathematics
