THIS ARTICLE DISCUSSES the scenario for consideration in this series of presentations on using debt wisely: Is the statement, “Loans which allow flexible repayments are better than those that do not”, true or false?
The answer to this is definitely, “it depends”. It depends on what the borrower plans to do with the funds and heavily on the expectation of future cash flow to support repayment of the loan. For example, if the borrower plans to purchase a home or a vehicle, he is probably better off taking a mortgage on the property or a vehicle loan. However, where the borrower is uncertain of the funds needed and when they will be needed, a loan with more flexible repayment terms may be better suited.
The typical sources of short- to medium-term funding for expenditures are by way of a personal loan, use of a credit card, use of an overdraft facility or use of a line of credit.
• The personal loan option is likely to provide minimum flexibility; the borrower is required to make regular instalment repayments and to repay the loan fully by the end of the loan term.
• Using the credit card to incur debt provides an interest-free grace period once there is constant repayment of the full credit extended when it is first billed. Where the balance outstanding is not repaid in full by each due date, interest is charged on the credit balance remaining. There is a minimum monthly repayment requirement. Late and/or no-payment penalty fees also apply to the use of the card.
• An overdraft facility raises the level of flexibility as the borrower can draw down funds as needed once the overdraft limit is not exceeded. Interest is charged only on the funds used by the facility. To the extent that funds are deposited to the account at any time to repay the credit so extended, the borrower will reduce or eliminate the amount of interest charged.
• A line of credit is similar to an overdraft in that the borrower also only pays interest on the amount of credit drawn from this facility up to the agreed limit. The special advantage of the line of credit is that it tends to bear a lower loan interest rate. Both facilities may require a set-up fee and a monthly service fee. Typically, unlike some personal loans, there is no earlier repayment fee.
Some bank customers establish overdraft protection on their chequing account so that if the account is overdrawn, the bank will extend the credit and charge the related fees and interest for the credit extended rather than return the cheque(s) unpaid. Such overdraft protection is really equivalent to an automatic line of credit.
Lines of credit somehow have not been as popular for funding personal credit needs, although there are worthy advantages of their use in particular circumstances. For example, a line of credit is likely to be cheaper than a credit card when used to support the unpredictable income of a self-employed person. The possible long delay between work performance, billing for the work and receiving payment can be bridged by a line of credit.
In addition, when a small business needs to deal with a supplier where credit has not been established or where the supplier will only accept cash, a line of credit can serve a progressive purpose. Further, a line of credit is handy in financing a start-up business when the entrepreneur can only estimate the funds needed to get the business going. He may be uncertain as to how effective will be the marketing and promotion effort of his product and therefore of how soon revenues will start to flow. The interest cost of the credit then becomes a business expense that is tax deductible.
• Louise Fairsave is a personal financial management adviser, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances. Email: Louisefairsave @nationnews.com
This column is sponsored by the Barbados Workers’ Union Co-op Credit Union Ltd.
