Indians lap up personal loans: How much should you borrow?

Get a personal loan in less than an hour; payday loans; convert your purchases into EMIs; apply for a loan online etc. It comes as no surprise that the unsecured loans portion of banks' retail loan books has been ballooning over the last eight years.

According to the Reserve Bank of India (RBI) data, in May 2010, the total outstanding personal loan amount with banks stood at Rs 5.89 lakh crore. This amount as on June 2018 was Rs 19.33 lakh crore. Consumer durable loans' as on May 2010 was Rs 8,138 crore, and on June 2018 it was Rs 20,300 crore. Outstanding credit cards' amount as on May 2010 was Rs 19,579 crore, and on June 2018 it was Rs 74,400 crore.
These are all unsecured loans, i.e., you don't have to give collateral to borrow.
Why are we borrowing more?
Since 2010, a lot of banks have changed their strategies and have started focussing more on retail lending. "The size of their retail loan books has gone up due to this change in strategy. Categories like mortgage and auto loans are not much of a worry because they are collateralized with fixed assets. The miscellaneous category is of interest as it is large in size and needs some degree of monitoring. These are generally unsecured loans that are usually taken for purposes like marriage, festivals, and even taken by bank employees themselves," says Madan Sabnavis, chief economist at CARE Ratings.

So, who all are taking these loans? "A large proportion of customers taking personal loans, consumer durable loans are working class in the age group of 25 - 45 years. In terms of geographic split, metropolitan cities (population greater than 10 lakhs) accounted for 80% of the credit card customer base in FY17. However, the share of metro cities has been continuously declining from close to 99% in FY12 to 80% in FY17," says Rahul Prithiani, Director, CRISIL Research.

According to RBI, as on June 2018, the total number of credit cards outstanding were 3.93 crore, and on June 2011 it was 1.76 crore.

Asset quality risks largely mitigated with enhanced risk management, technology and cross-selling
Source: CRISIL Research

Is there a reason to worry?
In developed nations like the US, many households are living way beyond their means. Many over there take payday loans just to make ends meet and some take credit cards to pay off existing card bills. So, will we see a day like this in India?

Prithiani says that traditionally, Indians have been more conservative and that even though there has been an increase in credit appetite by Indians in the past few years, households still haven't fallen into a debt trap.

It could be a matter of concern when loans are taken for consumption purposes which are unsecured. Sabnavis says that this would mean living beyond their means for some borrowers. "As long as the loan size is small, it would not be an issue. As the sums increase, there could be challenges on asset quality when there is a downturn in the economy. Another concern is that even though the number of credit cards has gone, a lot of people are not aware of how the interest rates on credit cards are calculated. This can be a potential pain point for banks as the magnitude increases," explains Sabnavis.

What borrowers should do
Yes, it is easier to get loans now than ever before. However, that does not mean that you keep taking them without considering the consequences - worst case scenario, you could end up in a debt trap.

Raj Khosla, founder and MD of MyMoneyMantra, in a recent column in ET Wealth wrote about what one should keep in mind while taking a personal loan (Read his column here https://goo.gl/esvJL7). One of the things that he said one should be mindful of is the interest rate. "The flat rate of interest is an oft used method to lure business. The flat rate is a misleading metric, because it does not take into account the reduction in the balance with every EMI paid by the borrower," he wrote. Further, he says that one should avoid zero percent EMI schemes. "People fall for this without realising that the high processing fee and file charges for the loan is where the lender is making a killing," he explains.

Don't do these three things
Now, even though it has become much easier for us to borrow, the rules of prudent borrowing remain the same. Here are a few rules to follow while taking a personal loan.

Don't borrow more than you can afford: Don't live beyond your means; take a loan that you can easily repay. "You should be careful how much personal loans you take on. Do not keep purchasing things on EMIs. Till the time your cash flows are suitable to handle the EMI outflows, it is fine. Don't go overboard," explains Mumbai-based financial planner Stephen Fernandes.

Don't default on your payments: Missing an EMI or delaying a payment are among the key factors that can impact your credit profile and hinder your chances of taking a loan for other needs later in life. Your credit card bill, make sure you pay the entire bill amount even though just paying the minimum monthly amount may seem enticing. It might be mandatory to just pay only 5 per cent of the credit card outstanding amount and the balance rolled over to the next month. Don't do this; it is one of the easiest ways to land in a debt trap. Here is why: https://goo.gl/NDd9Pe .

Don't borrow to splurge: If you go on to any payday loan website, you will see testimonials from young people talking about how easy it was from them to avail of a loan to fund expenses like a concert, a smartphone, or even a foreign holiday. This is not something you should do. Take the loan only if you need to. (A payday loan is a loan that is relatively low amount borrowed at a high interest rate for a short period of time.)

Mumbai-based financial planner, Suresh Sadagopan says that one should take a loan only to purchase something material like a home, car, or a consumer durable. "Avoid taking loans for general discretionary expenses," he says.

If you want to spend on a holiday or buy something expensive, start saving for it.