Technological interventions have changed the loan industry. Through emails, SMSs, and phone calls, banks and NBFCs bombard potential clients with lucrative loan offers. Customers can also use online aggregators to choose the cheapest loan and banks can approve and issue loans in a minute, even for individuals with a poor credit history.
While technology has revolutionised how loans are disbursed, the principles of judicious borrowing have not. Borrowing money without having a need is always a bad idea. Nishant Arora, Sixth Element Finserv Setup Services India, said that the first rule of wise borrowing is to live within means. “Borrow only when you are able to return quickly”.
Fixed vs floating
It is also important to carefully consider the differences between floating and fixed rates. The interest rate on a floating loan fluctuates from time to time, depending on the government’s policies. Fixed rates, on the other hand, provide a sense of confidence because the borrower knows the interest rate will not vary.
According to Nishant, EMIs for all of the loans combined should not exceed 50 per cent of an individual’s monthly income. Accordingly, EMI of auto loan should not be more than 15 per cent of monthly income, while the same should always be less than 10 per cent for personal loan.
Another crucial factor is tenure. All major lenders offer house loans with a maximum term of 30 years. The cheaper the EMI, the longer the loan term, making a 25-30 year loan quite appealing. It is, nevertheless, preferable to take out a loan for the shortest term possible. The interest expense for long-term debt is excessive. The interest paid on a 10-year loan is 57 per cent of the borrowed amount.
If the employee has been with the company for 20 years, the percentage increases to 128 per cent. It may be required to work for a longer period at times. If the term is ten years, a young individual with a low income will not be able to borrow enough. The ideal choice for such debtors is to increase the EMI amount each year in line with the increase in income. Increasing EMI in proportion to the increase in income, usually between 8 per cent and 10 per cent, will help in paying off a 20-year loan in less than ten years.
Don’t miss EMIs
Missing an EMI or postponing a payment are two major issues that might harm credit score and make it more challenging to obtain a loan for other purposes later in life. It is suggested that borrowers should not skip an EMI on loan, even if it means foregoing other assets.
Paying on time impacts CIBIL score, which is useful when applying for new loans because a better CIBIL score means a cheaper interest rate.
When a person borrows a home or car loan, it is better to get insurance. Purchasing a term plan for the same amount will ensure that the borrower’s family is not left with unmanageable debt in case of an untoward incident. If the family is unable to pay EMIs, the lender will take possession of the asset.
Typically, banks promote a lowering cover term plan that provides insurance up to the amount owed. A regular term plan, on the other hand, is a superior strategy to cover this risk. It can last even after the debt is paid off.
An unsecured personal loan, for example, can be replaced with a loan secured by life insurance plans. A loan against property might be used to pay off all other debts. Other possibilities to examine are gold loans and loans secured by bank deposits. Prepaying high-interest loans as soon as feasible is also a smart idea.
Look for better rates
A long-term mortgage should never be treated as a one-time transaction. Keep eyes and ears alert for new rules and interest rate changes. Ensure that the difference is good enough, at least 2 percentage points. Staying with the old loan’s prepayment penalty and the new loan’s processing fees will deliver no gain. Switching is also beneficial if done wisely.
Read documents carefully
Loan documentations are not exactly easy to read. Reading and understanding carefully the terms and conditions will avoid unexpected surprises. If the legalese is beyond comprehension, look for a financial counsellor or chartered accountant to review the agreement before signing it. It is always better to identify the pre-payment penalties and foreclosure charges before signing the loan documents.
Do not alter financial goals
Certain financial goals elicit strong emotions, particularly when they include children. No parent will choose to burden their children with a loan, especially for education, if they had the option. Using retirement funds to pay for children’s education can be a dangerous move. Students today have choices for financing their education, such as loans and scholarships, but there is no equivalent system to assist in planning for an individual’s retirement needs.loan