By Ciaran Ryan
Borrowers with more than one debt outstanding were given some protection last week when the Supreme Court of Appeal ruled that the interest rate on short-term loans after the first loan cannot exceed 3% a month.
Micro Finance South Africa (MFSA) had challenged regulations promulgated under the National Credit Act reducing the interest rate on a second short-term loan taken out in a 12 month period from 5% to 3% a month. The maximum interest rate on a first loan is 5% a month.
The regulations were introduced by the National Credit Regulator and the Department of Trade and Industry to provide some relief for over-indebted consumers. Many borrowers struggle to keep up with the repayments on their first loans and are forced to borrow a second time.
MFSA was unhappy with this reduction in interest rates on second loans, arguing it would reduce credit availability to those most in need.
MFSA, which represents roughly 1,200 microlenders, challenged the regulations in the North Gauteng High Court on the grounds that the changes were made without proper consultation and without considering the impact on both borrowers and lenders. The High Court originally ruled in favour of MFSA but this was overturned on appeal by a full bench of the court. That decision was also appealed by MFSA at the Supreme Court of Appeal, which has now ruled in favour of the NCR and DTI.
This means that the new regulations remain in force. Consumers pay a maximum 5% interest a month on the first short-term loan and 3% a month on subsequent short-term loans in a calendar year.
MFSA argued that the new regulations would drive people into the arms of loan sharks who operate outside the law and often charge much higher rates of interest.
Independent legal and financial advisor Leonard Benjamin believes the court ruling may provide some relief to those drowning in debt, but warns that there are other dangers facing them. One issue, he says, is lenders offering second loans to those already in difficulty.
For example, a person borrows R1,000, pays off R500, and then is unable to maintain payments and falls into arrears. The National Credit Act's in duplum rule -- an old Roman law written into the Act -- says borrowers can never pay more than double the loan outstanding. In terms of this rule, the most the borrower can be charged is double the remaining R500, or R1,000.
"One way the micro-lenders get around this very elegantly is to offer a second loan to those in financial distress," says Benjamin.
So in the above example, the micro lender offers the customer a second loan of R500 to pay off the first loan borrowed. But now the most the borrower can be charged in terms of the in duplum rule is R2,000, not R1,000.
"At an interest rate of 5% a month you very quickly reach that ceiling."
Nor does it end there, says Benjamin. Should the borrower again run into financial trouble, the micro lender often extends a third loan. "Borrowers at this end of the market can very quickly end up in a debt trap from which they can never escape."
Benjamin also points out that billions of rands in prescribed (expired) debt are being collected from South Africans each year. In terms of the Prescription Act, most debt (such as credit cards, overdrafts and store accounts) expire three years after default by the borrower, unless the debt is "re-activated" by the lender. The prescription (expiry) period on mortgage loans is 30 years.
Lenders can re-activate these expired debts by getting borrowers to admit (usually on the phone) that they borrowed the money. Another way to re-activate the debt is to issue summons against the borrower within three years of the first default.
Benjamin's advice is never to discuss anything on the phone with a debt collector, nor admit to anything, and demand that the request is put in writing.
Forensic accountant Andre Prakke says microlenders trying to recover expired debts also offer new loans of a much smaller value, on condition that the previous loan be added to this one and it becomes a new loan. All the costs are now rolled into the second, new loan. The result is a debt trap, where more and more of a person's monthly earnings are used to pay down debt.
"The interest rate when you take these two loans combined is outrageous. The debtor will probably never be able to repay it," he says.
As a result of the new loans and the compounded interest rates, situations arise where people started off by borrowing R10,000 and end up having to pay R100,000, says Prakke.
In other words, the original capital is usually paid off many times over, yet the borrower never escapes from debt.
"The new regulations to limit interest rates on second loans will provide some relief, but there are ways around this that borrowers need to take into account," says Benjamin.