In this high interest rate environment, the mind goes into overdrive and we begin to seek ways to cope with heavier repayment obligations. It is however critical that we understand the reasons behind the current environment.
Why do interest rates go up? Interest rates (or simply put, the cost of money) are affected by many factors, the most common being:
Inflation rate: For example, Kenya's inflation rate shot up to above 20% towards the end of 2011. Because money loses its purchasing power when inflation is high, those holding money will normally demand higher compensation to protect themselves against such loss.
Supply and Demand of Money: When supply of money is high (liquidity), interest rates tend to go down as those holding money seek to tempt those in need of money to borrow. However, if the demand for money is high and the supply side of money is less, then those holding money may demand a higher return because the competition for money is high.
Monetary Policy actions: If the Central Bank reduces interest rates for treasury bills, then banks (the highest investors in treasury bills) will prefer to lend their money to borrowers instead of investing in treasury bills, thus forcing lending rates down. However, if interest rates for treasury bills rate go up, then banks will rather invest in treasury bills than lend, but when they do lend, they will demand higher interest rates.
On the other hand, the Central Bank may opt to print currency to increase the supply of money to the market, thus causing interest rates to drop. However, printing money has other, not-so-welcome ripple effects in the economy.
What to do when the interest rates go up?
Negotiate: With the onset of credit referencing, a good credit history can actually work for you. You should be able to somewhat negotiate your loans and even repayments to suit your needs. Some borrowers usually make it a habit of evaluating their loans every year to ensure that they are still getting a good deal.
Also, prioritise your debts. You might find yourself with many loans and the repayments look daunting. Best thing would be to prioritise according to the interest obligation. Think carefully about discretionary loans, especially round short term borrowing needs.
Explore alternative sources of funding: Look for alternative sources of money such as your Co-operative Sacco, your investment group, or even your family. You could even raise money by disposing of some of your assets.
Borrowing only if you must: However, if you have explored all of the above and still need to borrow, go to your bank manager and ask for a loan. Try to repay this loan over a longer period to reduce the monthly instalment so you don't feel so much 'heat'.
What to do if you already have a loan?
Restructure the loan: If your monthly loan repayment was Ksh30,000 ($360) when the rate was 15%, it may have changed to around Ksh40,000 ($480) when the rate increased to 25%. An additional Ksh10,000 ($120) can wreak havoc on your budget. Go to your bank manager and ask to restructure the loan over alonger period or change the loan type. Doing this could reduce your loan repayment to Ksh 35,000 ($420) - a monthly saving of Ksh 5,000 ($60).
Pay off the loan: Paying off the loan as quickly as you can is the best way of saving you money and hassle. You save in two ways: 1) the interest payments that you would have continued to pay will now be your money. 2) The money saved is now available for investment and if you can get higher rates of return, you'll enhance your chances of building wealth.
Do nothing and suffer: You may also opt to do nothing and continue to suffer the 'heat' of the increased interest rates. However, you can lower the 'heat' by taking on contracts or start an income-generating activity that covers the increase in rates. Always taking into account the three buckets of success