What if we think of an ideal world?
It would be one in which everybody would have enough money for all their needs. But the reality is much different from this. In reality, many of us have little or no option than to borrow loan to meet our requirements. For banks and NBFCs, this becomes a tremendous opportunity. They can get numerous customers with loan offers through emails, SMSs and phone calls. Many offers are given by banks like low rates, offer quick disbursals, easy processes etc.
Technology has changed and with this new changes have come in lending industry. Online aggregators have helped the customers to get the cheapest loan and banks take less than a minute to approve these loans.
While technology has changed that lot, the customers have not changed. You answer, “does it make sense to borrow if you don’t need the money” or “take a long-term loan just to enjoy the tax benefits which are available on the interest you pay?”
Here, I am with 10 golden rules that the customers must keep in mind.
1. NEVER BORROW MORE THAN YOU CAN REPAY
Now, this is the first and the most important rule of smart borrowing. This is also what the older generation has been telling us all the time. There’s an old saying which goes like this “don’t live beyond your means”. You should take a loan that you can easily repay.
Here we can consider a small thumb rule that says that car EMIs should not exceed 15% while personal loan EMIs should not account for more than 10% of the net monthly income and this is what you have to keep in mind before taking loans.
2. KEEP TENURE OF YOUR LOAN AS SHORT AS POSSIBLE
If we talk about the maximum home loan tenure offered by all major lenders than it is 30 years. You will get to pay a lower EMI if your term period is longer. This makes it very tempting to go for a 25-30 year loan. Despite of all this it best to take a loan for the shortest tenure that you can easily afford. You have to see the other side too. In case of a long-term loan, the interest rate is too high. Say, in case of a 10-year loan, the interest paid is (57%) of the borrowed amount but this shoots to more than double (128%) if the tenure is 20 years.
But sometimes, it may be necessary to go for a longer tenure. Take an examole of a young person with a low income. He won’t be able to borrow enough if the tenure is 10 years. In this case he will have to increase the tenure. This is done so that the EMI fits his pocket. If these types of borrowers are considered, the best option is to increase the EMI amount every year in line with an increase in the income.
3. ENSURE TIMELY AND REGULAR REPAYMENT
It always pays to be disciplined. This is especially when it comes to repayment of dues. Whatsoever it may be, a short-term debt like a credit card bill or a long-term loan for your house, you should make sure that you don’t miss the payment. If you miss an EMI or delay a payment, these act as the key factors that can impact your credit profile. This hinder your chances of taking a loan for other needs later in life.
So, it is advisable, never miss a loan EMI. Pay EMI on time even if it means missing other investments for the time. It is definitely important. You should always remember to pay your credit card payments because you will not only be charged with a non-payment penalty but also be charged a heavy interest on the unpaid amount.
4. DON’T USE BORROWED MONEY TO INVEST
This is another basic rule of investing. You should never use borrowed money to invest. Taking here the example of Ultra-safe investments like fixed deposits and bonds, these won’t be able to match the rate of interest you pay on the loan. Coming to the investments that offer higher returns, like equities, are too volatile. In any case, if by any chance the markets decline, you won’t only suffer losses but will be strapped with an EMI as well.
In the same way, you should avoid taking a loan for discretionary spending. For example, you may be getting SMSs from your credit card company for a travel loan, but be careful. Always remember that such wants are better fulfilled by saving up. It’s never a good idea to take a personal loan for buying luxury watches and high-end bags. On the other hand, taking a loan for building an asset makes absolute sense.
5. TAKE INSURANCE WITH HUGE LOANS
If you take a large home or car loan, do remember to take insurance cover as well. You may buy a term plan of the same, which is amounted to ensure that your family is not headed with unaffordable debt if something happens to you in near future. Say, if something happens to you, the lender will take over the asset (may be house or car) if your dependents are unable to pay the EMI.
Banks, usually push a reducing cover term plan. This offers insurance equal to the outstanding amount. But, as per me a regular term plan is a better way to cover the loan. This can be continued even after the loan is repaid or if you switch to another lender.
6. ALWAYS KEEP SHOPPING FOR BETTER RATES
A long-term mortgage should never just be signed and later forget. You should always keep your eyes and ears open. You should be fully aware about the new rules and changes in interest rates. For example if the RBI is planning to change the base rate formula, this could also change the way in which your bank makes its lending rates. So, all you are supposed to do is to keep shopping around for the best rate. You should switch to a cheaper loan if possible.
One more thing to note here is that the difference should be at least 2 percent, otherwise the prepayment penalty on the old loan and processing charges of the new loan will eat into the gains from the switch.
7. UNDERSTAND THE FINE PRINT
Loan documents don’t make for light reading that is paragraph after paragraph of legal terms printed in a small font can be a put off. You should always read the terms and conditions carefully to avoid any unpleasant surprises. For example A Bengaluru-based business man applied for a personal loan of Rs 1 lakh but received a cheque of only Rs 91,800. This is so as the lender had deducted Rs 5,152 as an upfront interest charge and an annual insurance premium of Rs 3,047.
This all happened because Shetty had signed on the papers without going into the fine print. If you are not able to understand the terms do consult an advisor or chartered accountant to take a look at the agreement before you sign it.
8. SUBSTITUTE HIGH COST LOANS WITH LOW COST
Incase you have too many loans running, it’s a good idea to cover your debts under one omni low-cost loan. All you need is to make a list of all outstanding loans. Then identify the high cost ones that can be replaced with cheaper loans. For example, an unsecured personal loan that charges 18-20% can be replaced with a loan against life insurance policies.
9. DON’T MIX RETIREMENT BY AVOIDING LOANS
We Indians are emotional. We have certain financial goals, especially when it comes to our children. If given a choice, no parent would want to burden their children with a loan and that too for the purpose of education. But in securing your child’s future donot forget about your own. If you are securing your child’s future, you need to assess if it impacts your own future.
Dipping into your retirement to fund your child’s education can be a risky task. Nowadays, students have options like loans and scholarships to cover their education costs. But you should remember that there is no such arrangement to help you plan for your retirement needs. Do not plan for your children only.
10. NEVER KEEP SPOUSE, FAMILY IN LOOP ABOUT LOAN
Before you fully decide to take a loan, you need to discuss it with your family. This is too important. This is so because the repayment will impact the overall finances of the entire household. You have to make sure that your spouse is aware of the loan and the reasons behind you taking it.
You need to keep in mind that keeping a spouse in the dark on money matters increases stress in a marriage. It also lessens your chances of finding a more cost effective solution. It may happen that your mate has some spare money which can help you instead of taking loan. Don’t miss out that opportunity.
Now, that you are aware of the facts be a smart customer and apply these if thinking to take a loan.