Four things to look for before you borrow

Question: It is our first time to borrow and we are afraid of making a bad decision that will haunt us for the duration of the loan. Are there things we should watch out before we take the plunge?

Answer: Going in is easier than coming out. This precept cannot be all the more true for both investing and borrowing. But let us focus on borrowing.

Before you take out that easy loan for anything, from the gadget you have been pining for to the dream home you have been working hard to acquire, consider first the following four factors.

1. Is the interest quoted on simple or effective basis? The Bangko Sentral ng Pilipinas defines simple interest as the ratio between the peso interest paid and the original loan amount if the loan were settled with one payment after one year and with the amount of upfront cash received by the borrower equal to the said loan amount.

Any deductions made to the upfront cash to be received by the borrower—such as but not limited to loan processing fee, convenience fee, collection fee, notarial fee, handling fee, verification fee (and even coffee)—will have the effect of raising the interest rate, which is now the effective interest rate. In this case, the peso interest to be paid once after a year should be compared with the net upfront cash received by the borrower.

In MS Excel, and assuming that loan amortizations are on a monthly basis, the formula to use is =RATE(NPER,-PMT,PV)*12. NPER is the number of periods or term of the loan; PMT is payment or the monthly amortization expressed as a negative number as it is a cash outflow for the borrower; and PV is the amount of the net upfront cash received. Multiplying the result by 12 just converts the resulting monthly interest rate to an annual one (assuming your MS Excel automatically returns an answer in percent form; otherwise, multiply the answer by 100).

2. Compare the effective interest rate with those of larger commercial banks to see if what is being offered you is within market rates.

Is the interest rate quoted as a small percentage on a monthly basis? If so, ask if the method used to arrive at the quoted monthly interest rate is add-on-rate or A-O-R. If so, simply multiplying the quoted rate by 12 will not give the effective interest rate. To arrive at the effective interest rate, use the formula given in No.1, making sure that what is used as PV is the net upfront cash received.

3. Is the interest quoted for a one-time loan payment after a very short term like seven or 14 days? If so, use the formula =RATE(NPER,PMT,PV,-FV)*(365÷NPER). This time around, use the value “0” for PMT, use the net upfront cash received as PV and the negative of the one-time loan payment as FV or future value. Multiplying the resulting rate by (365÷NPER) is just to convert the periodic rate to an annual one.

In a related development, the Securities and Exchange Commission (SEC) imposed a cap of 15 percent per month on the effective interest rates imposed by lending and financing companies, including their online lending platforms. Also, lending and financing companies may only charge up to 5 percent per month for late payments on outstanding scheduled amounts due. And a total cost cap of 100 percent of the total amount borrowed, applying to all interest, other fees and charges, and penalties, regardless of time the loan has been outstanding, is imposed.

4. Ask if the lender will be charging loan processing fees when you prepay your loan partly or fully in advance. Under the Consumer Act of the Philippines, any unpaid balance of a consumer loan may be prepaid in full or in part at any time without penalty. Examples of consumer loans are housing, lot, vehicle, credit card and personal loans. Lenders take advantage of a loophole in the law by calling the penalty loan processing fee. Also, some lenders insist that prepayments may only be done during loan anniversary dates or when the loan was first released. If you face such a lender, just thank them for the offer and tell them you will be looking for one who does not charge for such prepayments and who do not insist that prepayments can only be done on loan anniversary dates.

It is so easy to borrow. It is in repaying such loans, especially with high rates, that the difficulty arises. INQ

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Efren Ll. Cruz is a registered financial planner and director of RFP Philippines, seasoned investment adviser, bestselling author of personal finance books in the Philippines and a YAMAN coach. To consult with a YAMAN coach, email [email protected]. To learn more about personal financial planning, attend the 98th RFP Program this Oct. 2022. To inquire, e-mail [email protected] or text 09176248110.