Things to note before you take a loan

Here are a few Things to note before you take a loan:

Things to note before you take a loanNow and then you may be receiving a phone call offering you some loan. Be it a personal loan or home loan; the banker is standing eagerly to grant you one. The ease of credit accessibility today as compared to yesteryear is commendable. Whether you require it or not, their pursuit is so relentless. Moreover, there has been an overall transition in the attitude of Indian society towards debt. It’s no more considered taboo. The level of persuasion is such that it won’t be strange that you may find yourself indebted one fine day.

Earlier, individuals perceived loans as a last resort to finance their need. But now the acceptance has grown to such levels that credit has become the primary source to fund the greed. Individuals as young as college grads are burdening themselves with debt like anything. Whether they have got the repaying capacity or not, it doesn’t matter. It seems there has been a growing insensitivity towards the consequences of debt.

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Are you planning to take one now?

But before you make a move, you need to know these three amazing facts about loans.

The first one is that “the bank would want it back”.

The second one is “the bank would want it back with interest”.

The third one is “the bank would want it back when it’s inconvenient to pay it back”.

You may wonder “That’s the basic common sense. What’s so special about it?” But you’ll be amazed to know that most of the individuals just forget the basics.

I guess by now you can understand the gravity of the situation.

Drivers of Loan Growth in India

It would be insightful to think about “What is driving retail loan growth in India”?

From late 1990 onwards, retail loans have been growing in India due to reasons like increased competition, higher disposable income, growing acceptability among the middle class, increased demand for housing in metros, the emergence of affluent middle class, over-leveraged corporate balance sheets, and the need to diversify risk among the banks.

Above all, consumerism can also be attributed for a growing affinity towards debt. The Indian demographics has improved considerably post liberalisation. The well-educated youth has become more ambitious and aspirational. They have always wanted to move to the next level. They even desire to possess goods which they can’t afford right now. Consequently, they regard debt as the easiest quick fix of the problem.

It has also affected their attitude towards saving, spending and investing. Individuals usually give priority to impulsive spending during their initial years of career. Due to the need for instant gratification, saving and investment take a backseat. Somewhere they become oblivious to the one fact. If they need to go into debt to solve a problem, they have a bigger problem than what they first thought.

Is debt so terrible?

Of course not!

Debt is a good thing. In fact, the entire banking industry survives because of debt. Loans are shown as assets on the bank’s balance sheet. The interest income generated on loans enables the banks to pay you interest on your deposits. The profits required to sustain the banking operations are made out of loans.

Even from an individual’s perspective, loans are a boon. It increases his current purchasing power and maintains demand for goods in the economy. It, in turn, supports the production and investment activity in the country. If there had been no loans, then India would not have been the biggest consumption market in the world.

But the problem arises when you don’t know where to draw the line. If you borrow beyond your credit absorption capacity, you may default on repayment. When you don’t pay back, it becomes a bad loan or a Non-performing asset on bank’s balance sheet. When this defaulting phenomenon occurs on a large scale, then it puts the entire banking system in danger of systemic risk.

Along with that, it also puts you in a bad light. Each time you default on your repayment dues, your credit score gets downgraded. A low credit score ultimately means low creditworthiness and may land you in trouble.

Your credit score is considered on many occasions. Whenever you apply for a loan, the acceptance or rejection of your application depends on your credit score. In the case of a low credit score, your application may get rejected on the spot. Additionally, it may hamper your eligibility to apply for bank exams and future employability.

Primary reason for default in loan repayment is irregular or unsteady income of the borrower. Apart from that, credit card also makes individuals fall into debt trap. They carry multiple credit cards and repay only the minimum outstanding balance. The remaining balance is rolled on to the next month. It would attract a huge interest, and in the case of default, penalties would also be levied. All amounts taken together make it big enough to surpass their repayment capacity. Borrowers default when they don’t plan beforehand how they are going to service the loan.

So, it’s very important that you introspect on all the aspects before finalising your borrowing decision.

Also read: Here is how to avail a loan against life insurance policy/fixed deposits/ppf/nsc

What’s the way out?

The telemarketing calls may seem tempting. But before making a decision to take a loan, you need to keep a few things in mind:

Consider loan as the last resort

Although loans offer many benefits, you need to stay rational when it’s the matter of debt. See there’s no pride in being indebted. You should consider the loan as the last alternative to finance your needs. Initially, try to stay within your income limits. Explore all the other options and savings. You can even opt to avoid taking loans by postponing your purchase decision.

Terms & conditions of loan

Having finally decided to take a loan, you need to understand the terms & conditions of borrowing. You should explore which bank is offering the cheapest loans. Usually, interest rates on loans offered by public sector banks are lower than private banks. Moreover, look for the shorter tenure of repayment. You will end up paying more by way of smaller EMIs spread over a longer tenure.

Avoid borrowing for depreciating assets

Borrowing sounds virtuous only when it creates assets which appreciate. Moreover, the interest outflow is allowed as a tax deduction. Home loans and education loans are ideal from this point of view. On the contrary, credit card loans and auto loans make less financial sense. They only buy you assets which depreciate and don’t give you any tax benefit.

Repayment capacity

Your repayment capacity to a large extent depends on many factors like age, income assets, dependents, consistency of income, etc. As a thumb rule, it’s assumed you would need 40% of your income as living expenses. If your income is Rs 50000, then your living expenses would be around Rs 20000. So, accordingly the remaining constitutes your credit absorption capacity.

Know your loan eligibility

You may estimate your home loan eligibility using simple formula i.e.

Home Loan Eligibility = (Monthly saving/EMI per lakh)*Loan Amount

Suppose you want to borrow a home loan of Rs 100000 for 10 years at 10%. The EMI for such a loan would be around Rs 1322. If your monthly savings are Rs 30000, then your loan eligibility comes around Rs 22.69 lakh {(30000/1322)*100000}

When you borrow, you create an additional charge on your income by way of EMIs. If you have already got a car loan liability, then going for a home loan/personal loan attracts implications. Your loan eligibility will be lowered by a number of previous loans that you are currently servicing. Moreover, you already have certain recurring living expenses which are unavoidable. So, while going for a second loan, consider your prior liabilities as well.

Avoid falling into debt trap

There are individuals whose primary chunk of salary ends up in paying EMIs. They seldom own things they possess. Be it their home, car, smart phone, or furniture; everything is on loan. So, they live from paycheque to paycheque and are stuck in a vicious debt trap. Even with a handsome income, they are unable to live life peacefully.

You need not fall into such a debt trap. There’s no financial wisdom in that. It only eats into your savings and makes you pay more for the same product by way of interest that you could have avoided.

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Final words

Loans are a prudent way for buying necessities now and keep paying later. The problem lies when it becomes an addiction, and you develop insensitivity towards the dire consequences. So, be rational and follow the precautions before borrowing.

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