What does a short-term loan really cost? Interest, fees and insurance

What makes up the cost of a short-term loan?

A short-term loan costs more than the amount you borrow because the lender adds charges. The National Credit Regulator lists the items that appear in a quotation: the cost of credit, interest, service fees, initiation fees, credit insurance if there is any, a deposit if one is required, the number of instalments and the dates of the first and last instalment.

In practice you will meet four main lines. Each one is regulated, and each should be written out in rands on your quotation.

• Interest: the charge for borrowing the money over the term.
• Initiation fee: a fee for setting up the loan, charged once.
• Service fee: a fee for administering the account, charged for each month of the agreement.
• Credit life insurance: an optional or required premium, depending on the agreement, that can settle or cover the debt in certain events.

Why is the interest rate not the whole story?

Interest is the most visible number and the one lenders tend to advertise. A rate that looks low can still sit on top of fees that make the total higher than a rival offer with a higher rate.

Some providers state rates such as 'from' a very small percentage on their offer cards. A 'from' rate is the lowest rate the provider uses. The rate you are offered depends on the lender's assessment of your situation and is shown in your own quotation, so always read that document rather than the advertised figure.

The Act prohibits charging interest above what the regulations allow, and the maximum rates differ by type of credit. The NCR publishes the current maximums, and we recommend checking them rather than relying on a figure printed in an article.

What are initiation and service fees?

The initiation fee covers the cost of setting up the agreement, such as the assessment and the paperwork. It is charged once, at the start. The service fee covers administering the account and is charged monthly while the agreement runs.

Both fees are regulated, and the regulations set maximums that are reviewed from time to time. Because the initiation fee is charged once, it makes a big difference to the cost of a very short loan, where its share of the total is larger.

Ask the lender to show each fee as a separate line in rands. If a fee appears under a vague name such as 'processing' or 'admin', ask what it is and which part of the Act allows it.

What is credit life insurance, and do you have to take it?

Credit life insurance covers your loan if certain events occur while you owe money. The NCR explained, when the credit life regulations were published, that the policy settles the outstanding debt if the consumer dies or becomes permanently disabled, and can pay instalments for a limited period if an employed consumer loses their job.

The National Credit Act lets a lender require cover that does not exceed what you still owe, and says a lender must not demand insurance that is unreasonable or unreasonably priced. If the lender proposes a particular policy, you must be told you have the right to decline it and substitute a policy of your own choice, provided that policy meets the regulations. A lender that accepts your own policy must tell you in writing about the relevant rules.

Read the terms before you agree. The NCR advises that you know what the insurance covers so there are no surprises when you need it.

Which other charges can appear if a payment is missed?

If an account falls into arrears, the lender may charge a default administration charge and may pass on collection costs. Both are regulated, and the quotation or agreement should explain how they work.

These charges are one more reason to match the repayment date to your pay date and to speak to the lender early if you will be short. Our guide on what to do if you cannot repay a loan explains your options.

What does the total look like in a worked illustration?

The numbers below are invented round figures for illustration only, not a quote from any lender, and they are not a statement of what the regulations permit. They show how two quotations for the same R2,000 over 30 days can differ even when one looks cheaper at first glance.

Quote B has the lower interest line, which is the number people notice first. Yet its fees and insurance make the total higher. The lesson is to add up every line before you decide.

How do you compare two quotes fairly?

Compare like with like: the same amount, the same number of days and the same repayment dates. Then look at the total in rands, not the rate.

The NCR notes that you can negotiate the interest when you get the pre-agreement statement and quotation, and that you can use these documents to shop around. Do not be shy about asking the lender whether it can improve the offer.

• Put the amount, term and payment dates side by side.
• Write down interest, initiation fee, service fee and insurance for each quote.
• Add the lines to get the total cost of credit, then add the amount borrowed to get the total repayable.
• Check the date of the first and last payment, and the rand amount of each payment.
• Ask whether insurance is required, and whether you may use your own policy.
• Ask what happens if you pay early or pay late, and get the answer in writing.

Should you ever pay a fee before the loan is paid out?

No. The National Credit Regulator states that an upfront payment for a loan is unlawful and that you should never pay one. A genuine lender shows its charges in the quotation and either deducts them from the loan or adds them to the agreement.

If anyone asks you to pay an insurance, admin or processing fee before you receive money, stop and read our guide on loan fraud in South Africa.