What is Consumer Debt, and Why is it Considered Bad? 

A report published earlier this year by the Kenya National Bureau of Statistics and the Central Bank of Kenya found that over 14 million Kenyans were taking loans from financial institutions. Almost half of the country’s adult population.

You can take out a loan for different reasons. You might be cash-strapped or need more money to complete a purchase. You might want to finance your education or business or settle an emergency expense. Or you are at risk of defaulting on a previous loan. Whatever your reason, debt can take you out of a financial fix when used correctly.

Debt can be categorised into two depending on how you will use it: Consumer and non-consumer debt. When taking out any loan, it is vital that you understand the difference between them.

This article will explore consumer debt, how it differs from non-consumer debts, its uses and benefits, and why it’s considered bad.

Read Also: 5 Tips to Mastering the Art of Debt-Free Living

What is Consumer Debt?

Ochieng, 33, is a Kisumu-based statistician who recently lost his job after his employer closed shop and relocated to a neighbouring country. He had savings that lasted him three months, and he has struggled to make ends meet for the last month. For four months, he has been unemployed but recently found a new job where he has been employed for two weeks.

One week into his new job, his son was sent home for school fees. Ochieng had already exhausted all his savings and was on the verge of selling his assets. But since he was expecting a salary that month, he opted to take a consumer loan from a mobile money lending app to foot his son’s fees.

So, what makes the type of loan Ochieng took a consumer loan and not a non-consumer one? Let's look at their definition.

Consumer Loan: This is a type of debt an individual, family, or household incurs through personal spending. This can be through purchasing goods and services for personal or family use. 

If, for instance, you moved to a new workplace further from your home and kid’s school and you’re prompted to buy a car but don’t have the cash to do that, you might opt for an auto loan, a type of consumer debt. Or if you decide to further your education by getting a master's degree, you can take a loan to finance it. If you want to repair, improve, or beautify your house, you take a home renovation loan. 

Apart from education and car loan, other types of consumer loans include mobile loans, overdraft loans, mortgage loans, debt consolidation loans, and credit card loans. These are all types of loans you take for personal or household use.

Nonconsumer Loan: This is a type of debt incurred and spent on non-personal use. It can be a loan incurred to start or run a business or debt incurred when you are fined, taxed, or pay penalties.

If you are a business owner and experience a cash flow problem and don’t have money to pay employees' salaries at the end of the month, you can take a short-term business loan to process your payroll. 

Back to Ochieng’s story, since he took a loan to pay for his son’s education, that will be considered debt spent on family, making it a consumer loan.

Read Also: Break the Cycle: 7 Simple Ways to Dig Your Way Out of Debt

Two Main Types of Consumer Loans

There are two main types of Consumer debts depending on how you will service/repay them – open-end loans and closed-end loans.

1. Closed-end Loans - This is a type of consumer loan taken for a specific purpose and is to be repaid within a specific period. At the end of the period, you must repay the total amount plus interest and other costs. 

Often, the creditor will require that you make installment payments after an agreed term like weekly, monthly, or quarterly. Examples include mortgage and auto loans. These loans are primarily secured, or creditors will retain equity in what they’re financing. Defaulting might lead to repossession of collateral.

2. Open-end Loans - This a type of consumer loan you can take and utilise for any purpose with the promise to repay (plus interest) within a certain date. The most common type of open-end loans in Kenya are mobile loans and overdraft services like Fuliza. Credit cards also fall under this category. Open-end loans are often unsecured.

Open-end lenders will often give the lender a limit. If your limit is Ksh10,000, you can’t borrow once you reach that limit. Additionally, you can borrow and repay as much as you like. Finally, creditors can increase or decrease your limit depending on how responsible or delinquent they find you.

Read Also: Top 5 Mistakes to Avoid When Trying to Get Out of Debt

Uses of Consumer Loans

Consumer loans can be used for a variety of personal and household needs, including:

• Buying a car for personal use
• Buying or financing the construction of a house for you and your family
• Buying products and paying for them later
• Paying tuition for higher education using HELB
• Consolidating existing debts etc.

Benefits of Consumer Debts

Over the past decade, consumer loans have grown in popularity in Kenya. The growth is driven by some of the benefits consumer loans provide. Benefits of consumer loans include:

• Flexibility - There are a variety of consumer loans you can pick depending on your needs. Also, open-end lenders won’t restrict how you use funds once they lend to you.
• Affordability - Consumer loans allow you to purchase products that could otherwise be out of your reach, whether a house, education, car, or the latest fashion accessory.
• Accessibility - if you have a good credit history with a lender, you can access as much as your loan limits with a few clicks on your phone. This easy access to funds can come in handy during an emergency.

Effects of Consumer Loans

Everything that comes with benefits won’t like some drawbacks. And consumer debts are not exceptional. The benefits consumer loans offer come at a cost that can affect your finances.

• Collateral For Future Income - Whether secured or unsecured, consumer loans have to be repaid. You are essentially spending your future income when taking this type of loan. The money you will earn will be spent paying loans instead of saving or investing. You are essentially spending your future income when taking this type of loan.
• Debt Cycle - Consumer loans can put you in a position where you become debt-dependent. You will constantly find yourself spending all your income to pay debts. As the circle continues, you will lose control and start taking more debts to pay existing debts.
• Overspending - Considering how easy they are to get, consumer debts can cause you to live beyond your means, ignoring your budget and overspending.
• Money Wastage - Consumer loans are not cheap. They come with hefty fees, penalties for delaying repayments, and high interest. This means you will be repaying way more than you borrowed hence wasting money.

Read Also: Coping With Debt: How To Deal With Debt of Any Size

Why is Consumer Debt Considered Bad? 

Different things can make a loan bad, but mainly debt can be considered good or bad depending on how you spend it. A loan used to fund a business that ends up paying itself and making you wealthier is good debt. A loan used to finance the purchasing of depreciating assets that produce no income or cost you more money to operate is considered bad debt.

So, what makes consumer loans bad debt?

1. Privacy Concerns - Some consumer lenders can infringe on your privacy by demanding a lot of personal information before offering you a loan. Others will require you to come with a guarantor. 

Additionally, other moneylenders, like mobile app loans, will require access to your contacts and harass them when you delay repayment.

2. No Financial Returns - In most instances, consumer loans are considered bad debt. Since the money will be for personal use, you won’t be able to generate any returns and will be considered liabilities.

And even when used to buy assets such as a home using mortgage loans, you might build your net worth as gain equity but only on paper. Unless your house appreciates and you resale, you will essentially be sitting on dead capital.

3. Slow you down - When you are constantly in debt, you won't be able to save or invest. This means you won’t be able to achieve your financial goals in time.

4. They’re predatory and can affect your creditworthiness - Consumer loan lenders are often strict with unfriendly and predatory terms. The loan is often short-term and must be repaid within stipulated deadlines that can be as short as 30 days. This can often prove problematic for most borrowers. 

Renegotiating terms and asking for more time can be hard when this happens. A lender will often penalise and increase rates with little or no warnings. 

Additionally, they will list on a Credit Reference Bureau as a defaulter when you fail to repay a loan of as low as Ksh50. This can ultimately dent your credit history, blocking your access to credit entirely.

Read Also: Critical Dos and Don'ts of Managing Your Money 

WRAPPING UP

Now that you know what consumer debts are, are they worth high-interest rates and long-term effects like the threat they represent to your creditworthiness? Take on loans that will help you build your worth and generate more income. 

Loans are not bad, but when taking them, ensure you incur one that will benefit you. Since most consumer loan loans don't fall into that category, you might want to think twice before taking them.

To avoid consumer loans, ensure you live within your means, develop passive income streams, have emergency funds and implement credit control to keep your debt-income-ratio as low as possible. Finally, before signing for any loan, perform due diligence to ensure you are not taking a nonbeneficial loan.