Loans: Don't let the lender outsmart you

Remember how our fathers and forefathers used to tell us to live within our means?

The things are different today. The interest rates have reduced considerably making them quite affordable. The process also has become more customer-friendly. Tax advantages to certain loans such as home loans have made then quite attractive. Consumerism has increased 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.

Yes, no doubt, the loan scenario is quite promising today. But we need to be careful.

Not all loans are good. Loans which finance the consumption are bad. Unsecured loans – such as credit cards, personal loans – are usually very expensive and must be shunned at all costs. Loans which 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 in the business? 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 critical of all the costs that you 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 EMIs – misleads many borrowers. Using this concept the lenders are able to quote lower interest rates. But the effective interest that the borrowing 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 costs could make your loan more expensive even though the interest rate may be lower.

5. Sometimes the EMIs 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 keep in mind that 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, then lower the better. This is more relevant to a longer-term loan like home loan which runs 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.

The author, Sanjay Matai, is an investment advisor. He can be reached at smatai@hotmail.com