How to best plan your credit journey

PUBLISHED: Mon, 11 Sep 2017 11:45:15 GMT

Christoph Nieuwoudt | FNB

Credit is a sensitive topic that can evoke a wide range of emotions from consumers. Positive experiences include the excitement and relief of being able to buy your first house or car, pay for studies, home improvements, furniture or even a holiday. The opposite experiences include despair or fear of not qualifying for credit, to being over-indebted or even losing valuable assets.

Unfortunately, statistics show that nearly 40% of SA consumers listed on credit bureaus (9.7m of 24.7m) have some level of impairment in their credit record and are perhaps closer to the latter category of experience when it comes to credit. Another view of credit is to examine the R1.7 trillion of consumer-lending by banks and other lenders, which shows that by value, only around 5% of this is classified as non-performing.  This apparent discrepancy can be explained by examining the range of lending products from large, low margin mortgages, usually to lower risk customers, to smaller, higher margin unsecured loans, often to higher risk customers.

The bulk of lending by value is in the form of mortgage finance (R884bn), followed by secured credit (R389bn) of which 90% of new credit granted is vehicle finance. The rest is made up of credit facilities (R224bn) such as overdraft and credit cards as well as term loans (R168bn). An analysis of financial statements of major industry players indicates that average net interest margins range from around 2-3% on mortgages, around 3-5% on vehicle finance, around 8-12% on facilities (overdrafts, credit cards) to 12-20% on unsecured term lending by major banks to even higher rates for micro-lenders.

Clearly these are average product margins and actual client rates are influenced by the client risk rating (assuming the lender does risk-based pricing) and also by the funding cost structure of the institution and of the asset type. For example, 20-year mortgage products are much more expensive to fund than shorter-term products.

This complexity makes it hard to create any kind of benchmark for pricing an individual consumer across products over different life stages.  In spite of this, I believe that almost every consumer can benefit from having a much better understanding of the purpose and cost implications of the different credit products. Hence it’s imperative for consumers to plan their ‘credit journey’, from first entering the credit market to eventually owning their dream house and having (a lot) more investments than borrowings.

The most basic fact is that almost everyone starts off with more ‘expensive’ credit products and by showing responsible behaviour i.e using credit products to purchase assets or to fund education rather than a lifestyle and unnecessary luxury items, and building a track record of good repayment can progress to availing of more inexpensive credit in larger amounts over longer terms.

Let’s breakdown each form of credit

Retail Credit

The starting point for most consumers in terms of formal sector lending and also by number of accounts is retailer lending/store cards.  The reason for this is very simple – retailers don’t actually give you money, but rather provide ‘finance’ against your purchase of goods from their store.

With retailer gross margins (against cost of goods sold) for many categories of credit retailers often being anywhere from 30% to 50%, it provides a large incentive for the retailer to finance goods to facilitate even ‘very high’ risk sales which may otherwise not have taken place. While retail credit helps to facilitate access to credit, it may not be ideal to a consumer from a value or cost of credit perspective.

Unsecured credit offered by banks

In terms of unsecured credit products offered by banks in the main, it is useful for consumers to understand their purpose and availability. For most customers, unsecured term loans would be a natural starting point in terms of access to credit.  The advantage for the customer is that there is no security or collateral required, and that it is readily available for a wider set of customers.

The size of the loan provided, the term over which it is available as well as the pricing of the loan typically depends on the customer’s credit score. This is why showing a responsible credit repayment profile can greatly assist a consumer to access a greater amount of finance while reducing the cost and/or the repayments.   As indicated the range of pricing is wide and good risk clients can obtain well priced loans for relatively big ticket purchases.

Consumers should be cautious though when considering term loans with very long repayment terms (e.g. longer than 60 months) as the total cost of credit can become high. When sourcing such credit, it’s important for consumers to be clear on the purpose of the loan and rather use it for creating longer-term value such as funding education or home-improvement and not for short-term consumption.

The next natural product for a customer may be an overdraft linked to his/her transactional account. From an FNB customer perspective, we believe every qualifying customer should consider an overdraft as (a) it is free, with zero monthly fee if not used, (b) the purpose is to provide immediate access to cash for emergency or simply just unanticipated payments and (c) there is no specific repayment, but rather the customer’s salary naturally ‘settles’ the balance every month.

Lastly, there is the credit card. The purpose of the credit card is to facilitate and fund customer spend, including providing protection from fraud and/or non-delivery of services or goods, insurance on travel and access to even richer reward benefits.  From a risk perspective, a credit card can present young or new to credit consumers with a challenge as it can easily be used for a prolonged ‘shopping spree’, resulting in a credit hangover. At FNB, we believe an optimal size of facility should allow at least the 55 maximum days of interest free operation, which is not too onerous for the customer to roll and repay within a reasonable period.

Secured credit including mortgages 

Vehicle finance is usually the entry product and buying that first car is an experience most consumers cherish for the rest of their lives. Building up a reputable credit record through responsible repayment of unsecured credit, including credit facility products which demonstrate control by the customer, and not being highly indebted are pre-requisites for a meaningful credit journey.  In our case, finance provided by our sister company WesBank (and its partners) naturally takes the FNB relationship into consideration to facilitate finance availability and pricing.

The ‘ultimate’ credit product which is best associated with long-term customer value creation is the home loan (or mortgage).  In my view, in all their earlier interactions with credit, consumers should keep in mind the objective of one day owning their own property.  This goes beyond just being responsible with credit and not being highly indebted, but also putting aside funds for a deposit if required.  For an entry-level house, typically a deposit is not required, but customers still need to consider the total costs associated with buying a house, including furniture as it is not recommended to finance furniture if you are considering buying a home!

Some may look at the total amount of interest payable over a period of say 20 years and conclude that mortgage finance is expensive.  I believe the perceived high cost should be offset against appreciation of the property value and relative to the cost of renting, which almost invariably results in a better financial outcome by purchasing.  Clearly, finance cost is also reduced where the customer can make payments in excess of the minimum amount.

To summarise, I believe that if consumers have an appreciation of the purpose, benefits and cost of various credit products and critically the importance of how they use (and not abuse) credit products, they will extract significant ongoing value from even simple products like the overdraft, credit cards and occasionally term loans, while being able to finance the purchase of key assets like vehicles and homes.

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