Why borrowers keep going for costly short-term loans

When broke, interest rate is not a factor. FILE PHOTO | NMG
When broke, interest rate is not a factor. FILE PHOTO | NMG 

Short-term unsecured loan companies such as Branch are using personalised marketing, sending individualised messages to consumers’ phones in a bid to entice them to take a loan through their mobile application.

Once the app is installed, the consumer is presented with a choice of loans that they qualify for. The loans start at Sh200 and it proceeds to inform one of the due date and the interest rates.

However, even if the consumer installs the application and deletes it later without taking a loan, the company will continue to send the messages that they are eligible for a loan and can easily contact them for help.

In this, the messages which are a constant reminder to consumers that they can get a loan through a mobile app will be at the top of their mind at a time when they are broke and need to settle their bills.

“Consumerism is overwhelming for many consumers, the desire to take care of oneself and not just the needs but also the luxuries can easily overcome the financial indiscipline to take a pay-day loan when they are enticed by such messages,” said Victor Rateng, senior programme officer at Twaweza East Africa, an advocacy research group.

“Even if the interest rates are higher compared to a bank loan, as long as it makes life easier in that it is easily accessible at the time, people will opt for it as solution despite it being costly. This, in turn, creates a poverty cycle because when one opts in, it becomes a habit because the constant supply of cash and the fact that one is given a specific period to settle it, is enticing.”

A pay-day loan’s interest is calculated on daily basis and one is required to repay the entire amount including interest at once, for a bank loan the repayment is spread over a period of time with flexible terms.

Yet when one is broke, the high-interest rate is not a factor. According to Harvard economist Sendhil Mullainathan and Princeton psychologist Eldar Shafir in their book Scarcity: Why Having Too Little Means So Much, when one has limited resources, it captures all their attention as they seek a solution to their problem.

“When scarcity captures the mind, we become more attentive and efficient. There are many situations in our lives where maintaining focus can be challenging. We procrastinate at work because we keep getting distracted. We buy overpriced items at the grocery store because our minds are elsewhere. A tight deadline or a shortage of cash focuses us on the task at hand,” said Mullainathan and Shafir.

The other marketing strategy that makes these loans attractive to consumers is that they are immediate. This makes it more enticing to the consumers indicating that the companies involved have understood the market and know the consumers applying for loans are seeking to meet their daily needs.

“They are quick to access, one receives the amount requested the same day and it does not require much documentation thus can sort out an urgent need. A bank loan, on the other hand, may take between three to five days to process; a pay loan takes hours or at maximum a day,” said A. Maiyo, a financial consultant.

- African Laughter