One mistake which hurt South Africans’ chances of buying a home

Even if you consistently pay on time, frequent use of short-term loans can signal poor financial discipline to home loan providers, harming your chances of securing a mortgage due to the high risk such borrowing patterns represent.

Renier Kriek, managing director of the disruptive home finance business at Sentinel Homes, warned that frequent short-term borrowing could be a black mark against you when applying for a home loan.

“The number of short-term loans you burn through may warn banks or other lenders that you’re having trouble managing your finances,” Kriek said.

That can make banks reluctant to fund your dream of owning property. All debt should be managed responsibly to maintain a good credit score.

However, for many South Africans, short-term loans are becoming an addictive way to make ends meet or to fund luxuries they can’t afford but refuse to live without.

It’s easy to get hooked as well, Kriek said. You don’t need to put up collateral to get one, and you don’t have to explain what you’ll use the money for.

Some people also think that they can submit themselves to a debt review if they fall behind on their repayments.

A debt review, introduced by the National Credit Act, is a legal process that allows individuals who are over-indebted to settle with their creditors by paying what they can afford. A registered debt counsellor will review their finances and help them create a repayment plan.

Unfortunately, Kriek warned that there’s no such thing as a free lunch. In fact, short-term loans can carry much higher interest rates than other types of debt, up to 5% per month.

This is around 6 times the current prime rate. “So, the more you borrow, the worse off you become financially and the more likely you are to default.”

That debt review “solution” isn’t necessarily a safe bet either. This is because it will cut you off from any further credit provision for as long as it takes to remedy your past bad behaviour.

Even if you’re not a repeat offender, firms offering debt counselling often assure you that your debts will be forgiven, the slate will be wiped clean, and all will be forgiven.

“In the real world, lenders could deny your home loan application simply because you needed debt review in the first place.”

A red flag for lenders

According to Kriek, short-term or unsecured loans are not inherently evil and should not be avoided entirely. When used responsibly, they’re actually good for the economy.

However, they’re also a red flag to home loan providers when they feature strongly in your financial history, even if you’re keeping up with repayments.

Credit providers use various risk models to identify patterns in our spending behaviour, good and bad. They know what financially responsible and irresponsible spending patterns look like.

“Frequent short-term loans, with or without defaulting, are a risky pattern that implies an individual does not manage debt well, and that is something a home loan provider does not want to make a long-term investment in.”

“The ability to delay gratification is the underlying attribute that responsible users of credit have, but there is no easy way to quantify whether a particular applicant possesses that trait.”

Therefore, Kriek explained that the number, frequency and type of unsecured credit transactions are used as a proxy.

However, if you already have short-term loans, that doesn’t mean all is lost. According to Kriek, several actions can be taken by people in this position.

First, understand that short-term loans have their place but are seldom necessary, he said.. Stop using them and make a plan to pay off the ones you already have.

Then, work on building an emergency cash fund that can only be touched for true emergencies, so that you will not need unsecured debt in those cases.

Second, work on saving for luxuries such as holidays and large capital purchases. Whether you take the credit or save, you will pay monthly anyway.

But in the saving scenario, interest will work in your favour rather than against you. Delaying the gratification of that large purchase is difficult, but no one said adulting would be easy.

Finally, if there is no other option, opt for “good” debt as far as possible. Buy your clothes, furniture, appliances, groceries and other items using store credit if you absolutely cannot do without.

You don’t have to buy things you don’t need to build a good credit score. Instead, opt for everyday items and normal household purchases.

“Credit providers’ risk algorithms generally look favourably on consumers who start their credit journey with store debt because it fits the pattern of responsible spending,” Kriek said.

Importantly, though, this is provided you pay your accounts on time and do not spend near or above your credit limit.

Kriek added that eventually, most people end up before a home loan provider in the hope of buying a house they love. However, lenders are profit makers and risk reducers, so it’s essential to think like they do.

Ask yourself whether you are a good investment and will repay your home loan on time and in full.

The lender’s modern analytical systems, often powered now by artificial intelligence, have evolved to answer questions like these and exist to protect their owner from risk.

“Short-term loans that literally fund your lifestyle can easily sway the algorithm against you,” Kriek said, “especially if you are funding luxuries or nice-to-haves from easy debt rather than developing the discipline of saving.”