Each one of us has borrowed money at some point or the other in our lives and for varied reasons. Regardless of the reason, a loan is a loan. And it is only when the burden is off your shoulders that you can really enjoy your happiness.
To ensure that the loan does not become an unbearable burden, you need to borrow within your limits. Better still, borrow smartly. Here are some tips to help you.
Shop for a good lender
Do a thorough research before finalising on a lender. Avoid borrowing from private money lenders, as they can be expensive. For loans, do take note that public sector banks offer better rates than private sector banks. Don’t just make rates your primary criterion; also consider the time for disbursement and lender’s effectiveness of services. As a borrower, you stand to gain from the intense competition among lenders, make full use it; shop for loans and do not finalise before visiting all the shops.
Choose your rates wisely
Loans go bad because of unrealistic rates of interest. Negotiate; doesn’t always work, but even if you get the rates lowered by 0.25 per cent, it’s in your interest. For home loans, choosing between fixed and floating rates is a dilemma most borrowers face. Here’s some advice:
Fixed rate: A common assumption is that fixed rates remain constant throughout the tenure; this isn’t true. Banks can change their lending rates after a few years depending on their policies. Remember to get this point cleared.
Floating rate: This is definitely a better option as the rates are lower than the fixed option. But again, look at the track record of the lender to check if the lender has reduced the rate in at least, last two years in a falling interest rate scenario.
Also, do keep in mind the economy’s rate of interest. For instance, currently rates are already low so now they can only go upward.
Borrow for long, pay early
The longer the tenure, the higher the interest you end up paying. Say you have borrowed Rs 20 lakh as home loan for 20 years at the rate of 9.5 per cent. Your Equated Monthly Installment [EMI] will come to Rs 18642.62. At the end of 20 years, you will have paid back Rs 44,74,229.70 as your loan amount. The interest component is Rs 24,74,229.70. That is right, the interest you pay is more than the principal amount. The smart thing to do is to opt for a longer tenure to lower your EMI, but start pre-paying your loan as and when possible.
Beware of all the charges
Be very sure of all the charges—the processing fees, pre-payment charges, foreclosure charges, switching fees, and late payment fees. Discuss all of these before finalising anything. Do remember that processing fees are often non-refundable, and paying processing fees does not guarantee sanction of the loan. Also, negotiate. Many banks lower the processing fees if you are their regular customer.
If you have more than one loan, you have the option of combining all of them into a single loan with revised rates and tenure. Loan consolidation has two advantages: you have to handle only one payment in a month rather than many; and you can lock-in lower interest rates.
Again, do the math and only shift if your total cost of interest plus other charges are less than what you are already paying.
Avoid borrowing against assets, cards
Borrowing against your assets—house, insurance policy, provident fund—is a strict no-no, unless there is an absolute emergency and all other avenues are closed. If you do borrow, pay back in time. Think twice before borrowing cash on a credit card, as the rate of interest is as high as 36 per cent per annum. Be aware of the rate of interest, late fees, and grace period offered for paying your dues. Many stores also offer co-branded credit cards. Do not borrow cash against them as the rate of interest is often higher than your regular credit cards.
Cover your bases
Whenever you take a huge loan, opt for a declining term insurance with it, so that your family doesn’t have to repay it in case something were to happen to you.
Pay back ASAP
Always start prepaying the loan that has the highest interest rates first. Hence, the order would be: credit card, personal loan, consumer durable loan, car loan, education loan and home loan. Why is home loan the last? Because you get tax benefits on it. Your interest component is exempt up to Rs 1.5 lakhs u/s 24(b) and Rs 1 lakh is exempted u/s 80C. Also the rate of interest on home loan is less. That does not mean you do not pay it back, but it can be kept for last.
Borrowing bloopers to be avoided
- To stay out of the debt trap, ensure that your yearly total debt payments are not more than 45 per cent of your annual take-home pay. Anything more means you are in trouble [deep one]
- Never borrow against your credit card
- Never miss your EMIs, as not only will you have to pay charges or face consequences of non-payment, but your credit history will also take a beating
- Never borrow money to invest, especially in equities.