Category: Debt Management

Am I borrowing money efficiently?

Am I borrowing money efficiently?

Loan is quite a popular financial instrument for meeting short term financial requirements. Many people tend to go for it without too much introspection. But before borrowing funds, there are certain rules that one must follow to avoid the debt trap of high interest rates and or weak repayment.

Golden rules to follow when taking a loan

While availing loans potential customers must keep in mind a set of golden rules which are as follows:

Borrow only what you can repay: The first rule of smart borrowing is taking a loan which can be repaid easily. Ideally, the entire EMI of all the loans should not be more than 36% of the total monthly income. One thumb rule says that car EMIs should not exceed 15% while personal loan EMIs should not account for more than 10% of the net monthly income. The loan to income ratio should be within acceptable limits.

Keep a short tenure : The maximum home loan tenure offered by all major lenders is 30 years. The longer the tenure, lower is the EMI BUT the interest becomes too high. This is because taking a loan is negative compounding. The longer the tenure, the higher is the compound interest that the bank earns from the borrower .Hence, it is best to take a loan for the shortest tenure which one can afford. For example, missing too many credit card payments leads to non-payment penalty charges and a huge interest on the unpaid amount.

 Regular Payments : One must be disciplined and make payments on time – be it a short- term loan , like a credit card bill or a long-term loan like house loan . Missing an EMI or delaying payment are one of the key factors based on which a person’s credit profile is evaluated and can be the cause of rejection of any other loan application in future. CRISIL and other rating agencies can be contacted to know you current credit rating in the industry.

Never borrow to splurge or invest : This is one of the very basic rules of investing. One should never use borrowed money to invest. Investments that offer higher returns, such as equities, are too volatile and with decline in the markets there will be losses from the investment which have to be taken care of over and above the loan EMI.

One should avoid taking a loan for discretionary spending, too and start saving as early as possible to take care for such expenses (holidays in exotic locations, buying that high end car etc).

Taking insurance with loans of huge amount: When taking a large home or car loan, it is best to take insurance cover as well. Buying a term plan of the same amount ensures that the family is not overburdened with unaffordable debt in case of demise/ill health of the borrower

A reducing cover term plan(Mortgage Reducing Insurance) can be availed that offers insurance equal to the outstanding amount. However, a regular term plan is a better way to cover this liability. It can continue even after the loan is repaid or if one switches to another lender.

Looking out for better rates: Once the loan is taken it is very important to be aware of new rules and changes in the interest rates. One should keep looking for the best interest rate and if possible , find and switch to a cheaper loan. Please read our research note on MCLR Rate and its benefits

Understand the fine print: Reading the terms and conditions written in fine print is a must to avoid unpleasant surprises and unexpected deductions.

Reduce the number of loans or rather high cost loans : If there are too many loans in hand, it is better to consolidate the debts under one low-cost loan. Identifying the high cost loans and replacing them with cheaper loans is advisable. For instance, an unsecured personal loan that charges 18-20% can be replaced with a loan against life insurance.  It is also a good idea to prepay costly loans as soon as possible. Windfall gains, such as performance bonus, tax refunds and maturity proceeds from life insurance policies should be diverted towards repayment of these high-cost loans.

Keeping family in loop about loans: This is important because the repayment of the loan will impact the overall finances of the entire household. The spouse should be aware of the loan and the reasons for taking it.

When to take a personal loan for your business

Yet to start a business : If the business is in the ideation stage or yet to start up, it may be difficult to raise money through a business loan because banks extend loans to a company that is up and running only. Hence, to fund business at the ideation stage, one may have to consider a personal loan.

 No collateral/guarantor to offer:  Banks generally demand collateral in lieu of the loan they extend for a business. A new company may not have a collateral to offer. In such a case a personal loan can be used to fund business.

When a business loan makes sense 

Business qualifies under CGTMSE : If as a Micro and Small Enterprise the company qualifies for the Credit Guarantee Scheme (CGS), business loan is the best option to go for. Under the scheme a business can get collateral free loans of up to Rs.1 crore.

Business has a good credit rating: An up and running business has chances of a good credit rating and if the credit rating of the business is good, getting a favourable business loan will not be difficult.

Debalina Roy Chowdhury


Dilzer Consultants