Salary advancement is an emerging lending product designed to address the need to maintain cash flows in exchange for an agreed upon percentage of future salary.
In light of the repeal of the interest rate cap and signing into law of the 2019 Finance Bill, the business of transacting very high interest rated loans to high-risk individuals is about to be dominated by salary advance loans whose business model encourages an accumulating cycle of debt.
For millions of Kenyans, salary advance loans are a response to a real need and is set to graduate as the only gateway to accessing credit. Desperate Kenyans turn to them when they need quick cash without realising exactly what they are getting themselves into.
Availability of a salary advance is too good to be true because it is. It is like a siren in Greek mythology, a creature half-bird and half-woman who lured sailors to destruction by the sweetness of her song.
Calculating the true cost of a salary advance loan is not a straightforward process. For most borrowers, repaying a salary advance of Sh100,000 can end up taking months, even years, and costing thousands of shillings.
This is because most borrowers do not understand the terms of the loan, specifically the annual percentage rates and the penalty for failure to repay within the timeframe of the loan. The only person that reads the terms and conditions is the one who writes it.
Before the repeal of the interest rate cap, a standard one-month salary advance loan carried a fee of three percent and 13 percent interest for any amount borrowed, translating to an annual interest rate of 156 percent. But as aforementioned, salary advance loans are often not repaid within the agreed timelines. Instead, the loans are often rolled over with more charges.
To put into perspective how much this costs, consider a Sh50,000 salary advance loan with a one month repayment term, a 13 percent interest rate plus a three percent fee, one would owe an extra Sh16,000 in only one month. If they do not have Sh50,000 now, is it likely that they will have a spare Sh66,000 in 30 days.
It gets worse when the consumer uses the loan for consumption instead of generating more income which would help them repay the loan and possibly generate extra cash.
Instead, borrowers usually use the loan for consumption and end up being psychologically coerced into taking another salary advance to cover the first missed payment as they scramble to manage other bills. Keep in mind that the longer one waits, the higher the interest charges and late payment fees in addition to the original amount borrowed.
Much as this type of loan delivers quick cash without requiring a credit check and often seems like an easy solution to a short term financial situation, it is obviously a terrible deal that can lead to an even bigger long-term problem.
A Sh50,000 loan that may have started as a short-term solution to a financial challenge can balloon into a debt of over Sh600,000 or more by the time the borrower wriggles their way out of this debt cycle.
Persons seeking salary advance loans typically have three major financial issues that need addressing; a lack of savings, lack of an emergency fund and bad credit. Once these issues are addressed one will never find a reason to take out this type of loan.
In a different age, salary advance primary borrowers would have been forgiven for being financially vulnerable as they are more credit-constrained, have low income and limited access to liquidity from mainstream financial service providers.
However, salary advancements can be categorised as one of the few predatory loans available with unrealistic paydown terms and sky-high interest rates setting up borrowers for failure. They mostly target the poor, minorities, the elderly, and Kenyans with little or no formal education or were recently laid off and desperately need quick cash for a medical emergency, to pay the rent, or even to put groceries on the table.
But even people with a salary above Sh500,000 are taking salary advance loans.
Although cash advance loans are dressed up as a convenient way to access money, they have expensive fees that can trap borrowers in a vicious cycle of debt that is usually hard to get out of.
Salary advance loans should only be considered as a last resort when one has exhausted other alternatives.
The writer is consultant at Profit $ Loss Consulting.