7 rules to follow when taking a personal loan

By Raj Khosla

There was a time when your paycheque made you eligible for marriage. Now it makes you eligible for credit, including unsecured personal loans and credit cards. Personal loan disbursements have grown at a scorching pace over the past two years. Banks and NBFCs, flush with funds after demonetisation, have relaxed lending terms and are using technology to make the process quicker and easier. Some banks claim to disburse loans within seconds of receiving the application. To cut a long story short, it has never been easier for salaried borrowers to access credit. Even so, here are a few things you must keep in mind before you seal the deal.
Pick the lender with care
Banks and NBFCs are carpet bombing customers with offers of personal loans at what they claim are very low rates. Don’t fall for the first offer you get on email or via SMS. Although it is convenient to say yes to a bank with which you already have a relationship, you may be missing out on better deals if you don’t research the market thoroughly. Shop around for the lowest rate using a loan aggregator website.

Calculate the interest rate
When it comes to financial jugglery, you can’t beat banks. 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. For instance, if you borrow Rs 5 lakh for three years at 12%, the total interest outgo will be Rs 97,857. The average interest paid per year is Rs 32,620, so the flat rate comes to barely 6.5%, which makes the loan look very attractive indeed. Keep in mind that if you are repaying a loan with EMIs, the interest should be calculated on reducing balance. The flat rate will not tell you the actual cost of the loan.

Shun 0% EMI schemes
The 0% EMI scheme is a clever ploy that lenders use in conjunction with distributors of consumer durables and lifestyle products. The RBI has clamped down on such schemes but some lenders continue to offer these on the sly. They offer an interest free loan to the buyer. 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. If you buy a washing machine worth Rs 50,000 at 0% interest for six months by paying a processing charge of Rs 2,000, you have effectively paid more than 14% interest on the borrowed amount.

Don’t opt for advance EMIs
Advance EMIs is another way that borrowers end up paying more than the contracted rate. Some lenders ask the borrower to pay 1-2 EMIs in advance at the time of taking the loan. If you take a loan of Rs 1 lakh for 18 months at 14%, the EMI comes to Rs 6,190. But if you pay two EMIs in advance, the effective loan amount come down to Rs 87,620. An EMI of Rs 6,190 means you are paying an interest rate of 17.5% instead of the 14% you are given to believe.

Check the other charges
Personal loans usually come with a processing fee, but some lenders slip in other charges as well. It may appear that a processing fee of 1-2% is not very high, but there is usually a minimum flat fee payable. Check the charges before you opt for the loan to avoid any heartburn later.

The cost of a personal loan

Source: Bank websites. List is only indicative and not exhaustive

Find out about foreclosure rules
While the RBI has directed banks not to charge foreclosure charges on home loans, other forms of credit still attract prepayment penalties. Lenders charge a fee if you pay off your loan early because early repayment prevents them from earning the interest they had expected from the deal. If the loan tenure is longer than 2-3 years and you expect your cash flows to improve in the coming months, it is advisable to pick a loan with the lowest foreclosure charges.

Don’t approach too many lenders
Shopping around for the lowest rate can also prove counterproductive. Every time an individual approaches a lender for a loan, his credit score is accessed to understand his ability to repay the loan. If you approach too many lenders individually, you might be seen as a credit hungry person and your credit score could take a beating. This why it makes financial sense to go through a loan aggregator portal to zero in on the best loan without compromising your credit score.

(The author is founder and managing director, Mymoneymantra.com)