Is it wise to save money and take a loan for personal expenses?

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

14 April 2024

Reader Wanjohi says that he has some Sh30 million that he plans to spend “on a personal asset that will not [yield] any monetary return” – like renovating his house. A banker has advised him to invest the money in tax free infrastructure bonds of 16 per cent per year and then borrow the Sh30M at 18.5 per cent p.a. for six years to finance his project.

The reasoning is that, at the end of a six-year period, he will have his Sh30M in the bond plus “interest of Sh 45 million if compounded every 6 months and still have my home”. Wanjohi asks: “Is this mathematically sound advice?”

The quick answer is no! This idea can only make sense is the rate of return from the bond is higher than the interest charged on the loan. I think this is a case of the banker trying to make some money at Wanjohi’s expense!

I suspect that this is the reason the bank made a glaring omission: he didn’t mention the loan repayments. For the Sh30M loan, Wanjohi will be paying Sh692,740 every month. In 6 months, the total repayment will be Sh4,156,440. In the same period, the treasury bond will pay him 8 per cent of Sh30M = Sh2.4M.

Therefore, he will need to look for Sh1,756,440 to make the payment for the loan; or Sh292,740 every month. In six years, the total repayments just shy of Sh50M (Sh49,877,280).

In short, at the end of the period, Wanjohi have Sh30M (principal) + Sh45M (interest) = Sh75M from the infrastructure bond; but he will also have paid out Sh50M towards the bank loan. Therefore, the net movement of money is Sh75M coming in and Sh50M going out; thus, he is left with Sh25M.

Now, assuming that Wanjohi can raise the Sh692,740 – let’s round it up to Sh700,000 – every month, then his best approach would be to spend the Sh30M on renovations and then save Sh700,000 in the treasury bonds each month.

The renovation work might take him about six months, and, in that time, he will have Sh4.2M invested in treasury bonds. At the end of six years, he will have over Sh50M in treasury bonds – and we haven’t even added the interest earned.

Even without compounding, the interest from the bonds comes to about Sh24M; therefore, Wanjohi will enjoy his renovated house and still have Sh74M cash – and no loan! This is a much better proposition, isn’t it?