What are loans and how do they work?

Written by: Adebola Williams

Contrary to popular belief; loans aren’t bad. It’s people who have a bad attitude and understanding of loans. Debt has bad street cred but it’s still one of the best ways to build wealth.

Have you lent a good friend money and they just ghosted you, didn’t pick up your calls for months or even dared to shame you for asking for your money? There are different conversations on Twitter with screenshots of conversations between friends about repaying a loan they borrowed.

Or have you come across someone trying to settle a loan by taking another loan from an unsuspecting third party? And when it’s time to repay the third party, they find another person to sell their story and just like that, the loan cycle continues.

Or have you ever tried to help someone with a loan because they genuinely need help and they say “I don’t like loans. I don’t want people to think I’m poor. Or think I can’t take care of myself.”. This one is even quite common here in Nigeria, a society that exaggerates self-preservation, being self-made and the grass-to-grace story. We are being groomed to be self-sufficient from childhood and when we become adults, we think of debt as one of the worst things you could ever get into.

All of these scenarios are the reasons I believe that Nigerians need a lot of education when it comes to loans. To be able to have the right attitude towards loans, you have to know:

• What are loans?
• How do they work?
• How do I leverage loans for personal and business gains?
• What are the questions I need to ask before I take a loan?
• What is a credit history?
• How do Nigerian lending companies operate?

And so much more.

In this article, we’ll be helping you learn all these. In fact, we’re the best people to teach you about loans.

Table of content

• Why Moni is the best place for you to learn about loans
• Introduction to loans
• Types of loans
• How loans work
• Loan Application Process
• Loan Repayment
• Defaulting on a Loan
• Conclusion

Why Moni is the best place for you to learn about loans

Moni is first of all a lending company. Moni kicked off operations here in Nigeria with just a few mobile money agents in Shapati in 2020.

We created a WhatsApp group and an Excel sheet and gave these agents non-collateral loans to run their businesses in the COVID era. One of the issues we identified with traditional lending businesses and other lending fintech companies in Nigeria was that the bottlenecks and requirements to accessing loans were a lot. There was usually much documentation involved in the loan process and it was usually time-consuming. What about recovery? You must have heard of shame and name.

Shame and name is a concept that some lending institutions use to recover their loans from borrowers who have refused to repay on time. Banks were the pioneers of this policy. They would print out the names, addresses and photographs of these defaulting borrowers and paste them to the public. They would print it out in public newspapers and media houses. Even the Central Bank of Nigeria did this in 2015 when its Non-Performing Loan portfolio was at an alarming 420 billion naira.

If you were taking a loan with a traditional bank or other financial institution, be prepared to deal with:

• Strenuous documentation
• Ambiguous application processes
• Delays
• High-interest rates
• Shame and Name possibility
• High collateral demands

What we have done at Moni is remove all these bottlenecks.

With Moni, you can access credit on our website or on our app. We have removed the documentation stress and the need to come into our office space. All you need is your internet, a few vital documents such as your valid ID and other details. In 3 minutes, you will be done with your loan application and our language is also simple so that everyone knows just what they are getting into. Our terms and conditions are in everyday language so that you know what we expect from you.

Our most important mission is to democratise access to loans in Africa and the first step to doing that is making sure that our interest rate is the best the market has ever seen. What is the point of making loans available to everyone if the interest will break their backs? When traditional banks were doing back-breaking interest rates, we were doing only 6% on our mobile money loans. This was one of the reasons we were able to serve about 10,000 merchants in our first year.

Getting people to apply for loans isn’t the hardest thing. Ask any lending company. People want loans. They’ll come and take your money. The hard bit is always getting people to repay on time.

We had a north star metric that we focused on and this was that our repayment rate had to be at 99%. For us to do this, we engineered a new risk engine from a system as old as time — communities and this was our first step in Community Banking.

We helped these businesses stay afloat with community-powered loans. To take a loan, you have to belong to a cluster. A cluster is a group of people who do business in the same catchment area and trust each other. Our collateral changed from properties to social reputation. For you to be eligible, you have to know people who trust you enough to bring you into their circle. This changed the game entirely and helped people to be accountable to each other and with this social accountability came our north star metric — a high repayment rate.

So when it comes to loans, we know what we are doing. We know what works and what doesn’t. We have also seen different behaviours towards loans and devised innovative ways to make sure that people don’t lose focus on why they got a loan in the first place.

Introduction to Loans

Loans were invented as a means to help people and businesses with the necessary capital to purchase the important things they need to grow and hit their goals. From buying a car to starting that capital-intensive business, loans are a type of financial aid.

The Central Bank of Nigeria (CBN) defines a loan as an amount of money given to an individual on the condition that it will be repaid on a later date, with or without interest. Other assets such as land, buildings and machinery can also be given as loans.

For something to qualify as a loan, there has to be:

• A lender: This is the person who gives the money or other assets. In most cases, it’s usually a financial institution like a bank or a fintech company like Moni.
• A borrower: This is the person receiving the money or other assets.
• Principal Amount: This is the amount of money given out as a loan.
• A Repayment Date: No financial institution gives a loan indefinitely. One of the conditions that both the lender and the borrower must agree on is the repayment date. This is the date that the borrower will repay the money to the lender.
• Interest Rate: This is the rate charged or paid for the use of borrowed money. It’s usually calculated as a percentage of the principal amount. If for example, Moni gives you a loan of N100,000 for 4 weeks at an interest rate of 4%, you’ll be repaying N104,000 to Moni.

Interest rates are very important when loans are concerned. Loans with higher interest rates take longer time to repay than loans with lower interest rates. This rate is the cost of borrowing money from a lender. It’s like paying a lender for taking their money for a while because they could have invested that money into something but they chose to lend it to you. Interest rate is how lenders make money. They lend you a principal amount and you repay the loan with extra money — the interest amount.

A loan is a demand-meet-supply concept. Someone needs money to make a purchase but doesn’t have it and there’s another person who has the money at hand. The guy with the money gives the guy who needs the money his terms and conditions, they haggle, agree, shake hands on it and money is exchanged. He then is able to make that purchase and will have to repay the guy who gave him the money.

Like we said earlier, loans are financial aids and you should consider them to:

• Expand your business
• Meet an emergency need
• Finance your projects
• Make a huge purchase
• Pay for a vacation

Types of Loans

Banks and other lending institutions have made different types of loans available. They have assessed the needs of people and businesses to draw up all these types of loans. Forbes records about 16 different types of loans but for the sake of this article, we’ll learn about the following types of loans:

1. Secured Loans: These are the types of loans that require a kind of collateral before they are given. Usually, a bank would demand something that is substantial like a property, land or a car; from a borrower before they give out huge amounts of loans. Occasionally, this collateral means lower interest rates. If a borrower defaults on repaying a secured loan, their collateral is seized by the bank and would be used to settle the loan.
2. Unsecured Loans: They are the exact opposites of secured loans; do not require collateral and their interest rates are usually higher than secured loans. Unsecured loans are usually reliant on the borrower’s credit score or credit history.
3. Personal Loans: These are the kinds of loans banks make available to people to be repaid at an agreed term. They usually have fixed interest rates and have to be repaid monthly.
4. Payday Loans: These are for salary earners who need an advance against their incoming salaries. The principal amount is usually a fraction of a borrower’s salary and they are usually short-termed. Payday loans are expected to be repaid when your cheque comes in.
5. Student Loans: These are loans that banks and the government make available to students for their college education. They are usually expected to pay back at a later time with an agreed interest rate.
6. Mortgage Loans: In these types of loans, real estate is the collateral. The bank gives the borrower cash and is expected to repay it in instalments over a period of time until it’s completely repaid.
7. Auto Loans: are available to borrowers who need funds to buy an automobile.
8. Business Loans: They’re available to businesses and organisations who need funds to expand, and cover some operation expenses or growth demands.

How Do Loans Work?

So far we’ve talked about the importance of loans and the different types available and now, we are at the crux of the matter. Understanding how loans work will help you make the right decisions as to when to lend, where to lend and how to repay a loan.

For you to be able to take out a loan, you need to be eligible for it. Eligibility is a function of your credit history and your ability to repay on time. Your credit history is a record of your debt and repayment. A credit history is like a financial report card that tells a lender if you’re a good fit for giving money. In Nigeria, there are credit bureaus that keep this record. Every time you download a loan app to get a loan, once you meet the standard KYC; your information is sent to a credit bureau to check if you have good debt behaviour. If they see a willingness to take and repay loans over a period of time, you’ll most likely be eligible for a loan. So if you haven’t taken a loan before, it doesn’t automatically guarantee that you’ll be eligible for a loan.

You also need to understand that they are costs associated with loans. Most banking institutions charge a certain amount to process your loan application. It’s usually referred to as application fees. This is one of the things we have eradicated at Moni. There are no hidden fees or surcharges associated with your loans. We also have made sure that our loans are insured. Every loan that Moni gives out to businesses is covered by our third-party insurance partner who makes sure that in case of loss or theft, the business doesn’t have to go under to repay the loans.

If you do not read every terms and conditions, make sure you read a loan’s terms and conditions. There’s a reason we show you the loan terms, there’s a reason we send it to your email and a reason we ask you to read and accept it before consenting to a loan. Many people don’t have the patience to do this and what happens is that they misunderstand the conditions attached to their loans which will ultimately result in late repayment and a bad credit rating.

Tip: Whenever you take a loan, make sure you ask questions about the terms and conditions and if you’re sent a document, go through it to understand what you’re getting into.

How Does Interest Work?

As mentioned earlier, interest is how lenders make money. When you take out a loan, you’ll not only be repaying the principal amount borrowed. You’ll be repaying with interest and depending on the type of lender or loan, there are different approaches to interest rates.

If a lender gives you a loan with simple interest, you can easily calculate your interest rate if you know your loan terms and repayment schedule. With simple interest, the interest rate is calculated on the principal amount only. There’s a formula for calculating simple interest:

Principal X Interest Rate divided by time.

For example, if you take out a 2 million naira loan for 5 years at 20%, your interest would be 2,000,000 x 0.2 divided by 5 which is N800,000.

Simple interest is a one-off interest compared to the interest you get on your savings. The type of interest you get on your savings is Compound interest, which is simply your money working hard for you over a certain period of time. On Moni, savings compound up to 21% per annum.

Now that you understand how interest works on loans, you also have to understand the repayment terms. This answers the following questions:

• When do you have to finish repaying your loan?
• What is the repayment schedule, i.e. how often do you have to make repayments?
• What’s the total amount you’ll be repaying?

After your loan has been disbursed to you, craft a repayment plan immediately. The loan already comes with repayment terms and if you miss out on the schedule, you are telling your lender that you do not keep to agreements and you’re breaching the contract between you and the bank. Make sure to repay your loan and be right on schedule.

The Loan Application Process

Do you remember how libraries work? In most schools, for you to be able to borrow a book from the library, you have to be a student of that school. A Covenant University student can’t go borrow a book from the University of Lagos. The next thing is that you have to prove that you’re a student by showing some ID. The Librarian would take your ID, double check it with the system and you’ll sign a small contract stating when the book will be returned and in the condition that it must be returned before getting the book. If you misplace the book, you’ll have to cover the cost or else, you’ll never be able to borrow a book from the library again. This is exactly how loans work. To get a loan, you must trigger a loan application process.

At Moni, we have a pre-qualification process. This is where we check you out. You have checked us out, done your research to see that we do what we say we do. We also check you out to make sure you are who you say you are. At this stage, we check:

• Your details — Name, Business, Date of birth, address, bank statements and so on.
• Credit History — If you have a good or bad credit score
• Eligibility Status — if you are eligible for the loan you want to apply for.

If everything checks out here, you move to the next step which is the main application process.

Traditional banks usually do their loan applications through papers and a few visits to the banking hall while digital lenders have moved this process online. With a few clicks, you can complete the application process on most loan apps. You fill in a bunch of information like your name, your address, your next of kin and then you upload a few documents like your bank statements and a valid ID.

The next stage is application processing. Now, we have received your application and will review it for accuracy before we get to underwriting you or disbursing the loan to your account. Underwriting is assessing the risk of giving you the loan you’ve applied for. A few factors are put into consideration like your creditworthiness, credit scores, risk scores and our unique risk engineering process that helps us make the final decision. After this, we communicate our decision to you. If you are going to get the loan, you get the terms and conditions for the loan.

The last stage is loan disbursement. Both parties have agreed to the terms of lending and you get your loan credited to your account in the time stipulated.

Loan Repayment

This is the full-circle moment. It’s the process of paying back a loan. Depending on the contract between you and the lender, you can repay weekly, monthly, a lump sum or a combination of different schedules.

When you repay your loan on time, you are improving your credit score and this will eventually help you access future loans. You can stick to your payment schedule or fully repay it at once if you have the funds available.

Early repayment, like on-time repayment, is also good.

Late repayments are not good at all.

Tip: Avoid late repayments by all means. If you’ll ever be late on a loan repayment schedule, communicate it to your account manager.

Defaulting on a Loan

When you’re late or not making repayments, that’s a loan default and this may limit your access to credit in the future and if it’s a collateral-secured loan, you are exposing yourself to the risk of losing your assets.

The way loan repayments work, it isn’t immediate that not repaying your loan becomes a default. There is a grace period where it’s still just a loan. Once you have exceeded 90 days, your loan has become delinquent and what happens usually is that banks will inform credit bureaus that your loans have become delinquent and that means you’ll be flagged. Credit bureaus will see you as someone to not lend to or a risk to lend to.

After 3 months, the delinquent loans then go into default and this is the stage that lending institutions take legal action against lenders. It doesn’t have to get to this, you can cut out a different repayment method with your lender when you can’t repay your loan on time.

So, what do you think of loans so far? Would you consider taking a loan for your business, rent or general life?