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The Loans
In today's economic environment a loan can
improve your quality of life significantly, without
really hurting you. Discover how loans can enrich your life ...
What are the different types of loans.
Credit Lines/Overdraft: Your bank can if it desires offer
you a facility by which you can draw more money from your account
than you have by offering you a credit line or an overdraft. Such a
facility is extended depending upon your relationship with the bank.
However, such a facility is usually extended only for business
purposes.
Mortgage Loans: You can take a loan by mortgaging your
assets. You can mortgage assets that you already own (eg gold, Jewellery,
shares, deposits, real estate, etc) or those you plan to acquire
with the loan (eg real estate, car, etc.).
Unsecured Loans: These are loans given on the strength of
your income and repayment capacity.
Who offers Loans?
Banks, financial institutions and dealers of consumer durables
are the common sources of loans. Others who offer loans are Life
Insurance Corporation of India, Post Office, etc. The latter,
however, offer loans only on the basis of the assets that you have
with them.
What is involved in taking a loan?
| To avail loans typically the
lenders ask for: |
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Proof of the cost of the asset you
want to finance |
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A Security - usually in the form of a
mortgage of the asset that is to be financed |
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A guarantor - a third party who will
guarantee to repay the loan to the lender in case you
default on your loan payment |
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| There is a class of loans that is
also available today where none of the above is required. All
you need to provide are proof of your income, residence and
post-dated cheques covering the repayment and you can get the
loan. |
When to take a loan?
A loan that is taken to finance the purchase of an asset is
preferable to taking a loan to finance day-to-day consumption.
Even here some judgment requires to be exhibited. If one takes a
loan to finance an asset whose value is going to come down in the
future, then the individual is paying more. In such a situation it
is preferable to save money and buy the asset, since the value of
the asset is going to come down in any case and purchasing the asset
will become more affordable with time. For example, consider prices
of durables. In the last five years prices of most durables have
reduced and are reducing every year. Thus, waiting a little while
will not only allow you to build up the savings to purchase the
asset, but also let you acquire the asset at a lower cost.
A loan comes in handy when the cost of the asset you want to buy
is more than your total income in six months.
If taking a loan is going to replace your existing expenditure
then a loan makes a lot of sense. For example, you may consider
buying a car or a two-wheeler with a loan, since you are already
spending money on transportation. The additional cost that you will
incur in servicing the loan will give you a lot more flexibility
than being dependant on public transport.
A loan is recommended when you are financing a long term asset
like a home or investments in equity, mutual funds, etc, since the
cost of acquiring these assets in the future is likely to be always
higher than in the present.
Another benefit of taking loans is to plan your taxes. Some
categories of loans, such as housing loans, give you tax benefits,
by allowing you to set of part of the principal repayments and
interest payments against your tax liabilities.
How much of a loan to take ?
The amount of loan one can take depends upon the inidividual's needs
and capacity.
However, professionals advise that the total of your repayments
for loans, that is principal and interest, should not exceed 40% of
your post-tax income. Of this 30% of the repayment should be for
long-term loans (for durations of 10 or more years) and 10% for
short-term loans (for durations of 5 years or less).
A loan has a lot of nuances, learn them before venturing forth
Calculating interest on loans
There are many ways by which institutions calculate interest on your
loans:
Flat: Interest is calculated on the amount borrowed
throughout the period of the loan even if repayments have been made.
Diminishing balance: Interest is calculated only on the
principal amount that remains to be paid and for the period it is to
be paid.
Specified rests: Interest can be calculated for different
periods, called rests. This means that the interest will be
calculated on the balance of the principal at the end of the rest
specified. For example, if the rest specified is one day, then the
interest will be calculated each day.
Equated Monthly Installments (EMIs)
An EMI is a fixed sum of money you pay every month towards the money
you have borrowed. Typically, this covers both principal repayments
and interest payments. This practice is very convenient for
borrowers to pay loans off.
When you receive your loan statement you will observe that in the
early period of the loan most of the EMI is set-off against the
interest payment. Thus, even if you have paid your EMIs for half the
period of the loan, you will still find that your principal amount
has not reduced significantly. This practice is observed due to
accounting regulations. However, this does not mean that you end up
paying more.
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