Debt was, once upon a time, considered to be bad. Our father and forefathers used to avoid debt like a plague. Remember how they used to tell us to live within our means?
However, times have changed. Interest rates have reduced considerably, making loans quite affordable. The process too has become more customer-friendly. Tax benefits to certain loans, such as home loans, have made them quite attractive.
Moreover, consumerism has boomed making us wanting to enjoy things today rather than wait for months/years to save sufficient amount to buy things of our choice. Therefore, today we don't think twice before committing ourselves to indebtedness.
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Yes, no doubt, the loan scenario is quite promising today. But we need to be careful.
Not all loans are good. Loans that finance consumption are bad. Unsecured loans - such as credit cards, personal loans - are usually very expensive and must be shunned at all costs. Loans that strain our finances must be curtailed.
Loans that build assets are worth a look. While the competitive environment may have made availing a loan affordable and simple, it does have a drawback. In their eagerness to get the business, the banks may not always tell the full story. Therefore, it is for us delve deep into any loan offer and make the right choice.
1. Firstly, one should do a detailed market survey of the various options. Who are the major lenders? What are the interest rates that they offer? What are the other costs and charges that they levy? What terms and conditions are likely to affect us? Preparing a comparative chart would be very useful.
2. Interest is the most significant of all the costs that you would have to pay. Hence, needless to say that one should go for the cheapest option. But beware of the jargon.
Don't be misled by banking terminology. For example flat interest rates may appear to be cheaper but are in fact the most expensive - a 8% flat rate would work out to an effective cost of around 15%. Therefore, choose a daily or monthly reducing balance option rather than a half-yearly or annual reducing option. This will mean lower effective cost for the same stated interest rate.
3. Another concept - advance Equated Monthly Installments - misleads many borrowers. Using this concept the lenders are able to quote lower interest rates. But the effective interest that the borrower ends up paying works out much higher. Therefore, it would be prudent to go in for a plain vanilla loan rather than exotic variations.
Interest-free loans or other such offers are too good to be true and thus should be viewed with suspicion.
4. Apart from interest there will be other costs such as administrative fees, processing charges etc. Work out as to how much these other costs add up to. These could make your loan more expensive even though the interest rate may be lower.
5. Sometimes the instalments may work out more than what you can afford on a monthly basis. This can be reduced by increasing the loan tenure (or, of course, by reducing the loan amount) and make it convenient for you to avail the loan. But note that in such cases the total quantum of interest you pay over the loan tenure will be higher.
6. Make sure that all verbal discussions or offers are supported by relevant papers. Do not go by anyone's words. What ultimately matters is the written word.
7. Do not give any false information. Sometimes you may be coaxed into declaring something which is not the truth. Desist from any falsification. This amounts to fraud and could land you in serious trouble.
8. Ideally, one should ask for zero penalty/fees for a pre-payment option. If this is not possible, negotiate for as low a charge as feasible. This is more relevant to longer term loans, such as home loans, that run for 10-15 years. During such a long period circumstances could arise necessitating you to prepay the loan - interest rates may become too steep; your income may have increased substantially leaving you with lot of spare cash; tax structures may have changed making the loan unviable; etc.
9. Recheck all terms and conditions before you finally sign the documents. Ensure that interest rate, loan amount, tenure etc. are what was agreed upon.
10. Do not sign any blank documents or leave any blank spaces in the loan documents. Even if you have to spend a few hours to fill-up the form in full, do so. Do not leave anything for the lender or his agent to fill-up.
Remember that there is no free lunch. In this age of information overload, alluring advertisements and unbridled consumerism, it is easy to get bedazzled and baffled. Therefore, it calls for our ingenuity and intelligence not to be deceived and make the best possible loan choice.
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