rediff.com: What you should know about loans


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June 1, 2000

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Larissa Fernand

Quicker you settle the loan, lesser you eventually pay
The shorter the repayment tenure, the lesser the amount that goes out of your pocket. The only problem being that the equated monthly installments (EMIs) are much higher and could cause a tremendous financial strain.
Take the example of a Rs 200,000 loan with a 14 per cent rate of interest calculated on an annual reducing basis. The difference between the 5-year repayment tenure and the 20-year one works out to Rs 312,780: a phenomenal saving.
But for five years, you will have to dish out Rs 4,855 a month, as against Rs 2,517 a month for a 20-year period.

On the flip side, if you take the 10- or 15-year repayment tenure into account, the value of Rs 2,000 will drop substantially since inflation will have an impact on the value of the rupee. What you would be able to purchase with Rs 2,517 then will be much less than what you can do with that amount today. Moreover, your income will increase making the Rs 2,517 per month a small payment. Repayment tenure (years)

Repayment tenure (years)	EMI (Rs)	EAI (Rs)	Total (Rs)
5	4,855	58,260	291,300
10	3,196	38,352	383,520
15	2,714	32,568	488,520
20	2,517	30,204	604,080

Interest rate is not the only cost factor
When budgeting for a loan, don't just take the EMI into account. There are other expenses, too. Never underestimate how much the processing and administration fees amount to. A one per cent administration fee and a one per cent processing fee on, say, a Rs 500,000 loan, would amount to Rs 10,000. Other times, it could be just one fee (either administration or processing) but could yet work out to be much more if it is considerably higher at, say, 2.5 per cent or 3 per cent.

The amount may appear miniscule in comparison to the loan amount. But remember, that the full amount is never financed. An apartment costing Rs 1 million may get 85 per cent financing. So, you will have to arrange for the remaining Rs 150,000. If you take this into account, the additional thousands will definitely put a strain on your finances.

Interest rates can lie
Just because one financier is offering a lower rate than another, it does not mean that you will end up getting a cheaper deal. The catch lies in the method of computation. The more frequently calculated, the better the deal. Going by this principle, a daily reducing balance calculation is better than a monthly, which in turn is better than an annual. The most deceptive being the flat rate. Of course, no player really charges a flat rate but financiers often state the flat rate because it gives the impression of a cheaper deal.

Pre-payment is not always encouraged

Should you come into some money, you may decide to pre-pay your loan. And this may not always be welcomed by financiers. Currently, the trend is to do away with this pre-payment penalty but you should check with your financier.
It could be a fixed stadard amount or it could vary (one per cent of the loan sanctioned, two per cent of the balance amount, a month's interest, two per cent of the amount pre-paid).
Once you pre-pay a particular amount, the EMI is restructured accordingly.

If the penalty is too high, it may make more sense to invest the money that you were going to pre-pay. But you will have to ensure that your investment will get you more money than the savings would have on pre-paying the loan. Ask the finanicer what the revised EMI would be once you have pre-paid your loan. Subtract this amount from the current EMI and you get your savings. From the savings further subtract the penalty and see what you are left with. If the savings turn out to be a small amount and you would get a higher return investing your money elsewhere, don't pre-pay the loan. It will become more insignificant if you repay it towards maturity. If you still have a long way to go, then it would make more sense.

In the case of a housing loan, it may also make sense not to pre-pay considering the tax benefits.

What's considered when a loan is being sanctioned

The first basic requirement is that the loan amount that you need should fall within the lower and limits of the financier.

Then comes your income. Generally the EMI should not exceed 35 per cent to 40 per cent of the gross income. Also, if you are taking a loan for just Rs 500,000 and the property is worth Rs 1 million, then they will want to know the funding source for the balance amount.

There is always the minimum and maximum age requirement. Obviously a 35-year old individual will get a higher loan sanction than a 50-year old individual who is approaching retirement.

Servicing other loans? That means your disposable income decreases. You now have less money with which you can pay back this loan. So your chances of getting a hefty loan drop.

Ditto if you have too many people depending on you. Is your income supporting your wife, child and parents? You will get less than an individual whose wife is also employed and whose parents have an additional source of income.

Even if your income is not too high but there are plenty of investments in your name, that should be a plus point in your favour.

A steady job, good qualifications and employed in an industry with good growth potential, then you are a winner in their eyes.
More than anything, the customer should be comfortable repaying the loan. So even if you are entitled to take a higher loan, you may ask for a lower amount if you are not comfortable with such a high monthly outgoing.

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