Loans
have become a part of our life as they have become easily available nowadays.
Banks, Housing Finance Companies and Non Banking Finance Companies all are
marketing heavily to sell the loans to you. Different offers and teaser are
available to attract you to take a loan. Most of us apply for loan when there
is some emergency and also without understanding impact of interest in the long
run. One needs to understand that this may seriously affect fulfilment of your
goals. Your net surplus of income should be allocated and regularly invested
systematically for achieving your financial goals. If you opt for any unplanned
loan than it will definitely reduce your available surplus for regular
investments planned and will adversely affect building of corpus for your
financial goals like children’s education, marriage and retirement etc.
Recently
one businessman attended our free financial planning work shop and during one
to one interaction with him he confessed that I am earning very decent amount
but at the end of month “ kutch bachta nahin hai ”. He then realised the need
for financial planning and opted for our financial planning service. While
analysing the data collected we observed that he has four loans simultaneously
running which included home loan, property loan, car loan and above all loan
against his credit card. His monthly family income is 1.67 lakhs which is very
decent by any standard but at the same time he is paying 0.91 lakhs as EMI for
different loans. We realised his problem as to why he was not able to save
enough for future goals. We did an overall review of his assets and liabilities
and suggested him to prepay some of his loans bearing more than 12% interest.
Surprisingly he is paying interest as high as 15% on his home loan taken while
the same can be availed at around 10.50%. Thus we advised him to shift his
existing home loan to any other banker which offers home loan @ 10.50% to 11% p.a. We also advised him to go for floating rate
of interest instead of fixed or teaser loans. Since there is no pre payment
penalty in case of floating rate of interest now and a lot of banks have
offered to waive the processing fee, one should take the maximum advantage of
this by shifting their high interest bearing loans to other lenders offering
lower rate of interest.
So
for what purpose one should borrow? The answer depends on purpose for which a
loan is taken. In order to help a layman take informed decision about loans we
have designed AI & A test for deciding whether a loan is good or bad. The
first important criterion is loan should either add to your Asset or it should
add to your Income. The second test is that it should be Appropriate for your
circumstances. Banks or financial institutions normally give loan so that the
aggregate of all your EMI do not exceed 50% of your monthly income. But a
prudent financial planner will advise you to keep this ratio at 35%. This means
your monthly EMIs, of all your loans taken together, should not exceed 35% of
your monthly income. So the first and second condition should be satisfied to
arrive at a decision whether loan is bad or good. Let us take the examples of
different loans available and understand whether that loan is good or bad.
Home
loan: home loan
will definitely add to your asset but one has also to see that the loan is
appropriate. Appropriateness should be judged with reference to your ability to
service future EMIs. It may also add to your income if you let it out and earn
rental income. Home loans are also good as these gives tax benefits and thus
help you save tax. However one needs to be very careful while buying home for
investment purpose. He should look at his/her overall asset allocation. One
should not be overboard on single asset class.
Education
loan: Whenever you take loan for yourself or your
children’s higher studies that definitely will add value to your or your
children’s career. This will result in higher income in future. So though
education loan does not add to your asset, it adds to your professional
qualification and leads to higher income thus passing one of the tests.
Interest paid for education loans are also eligible for tax exemption and thus
help you save tax. One of the other advantages in education loan is no interest
is payable during the course period and repayment starts after the completion
of the course and you starts earning enough.
Vehicle
loan: Vehicle loan is not adding anything to your asset
base for long term because it starts
depreciating immediately when it comes on the road, but it can add to your
income. It depends on your profession or business to take a final call. If you
have to frequently travel for your business and profession and public
transportation available in your area is not good than it is better to have
owned vehicle. So in some cases vehicle/car loan adds to your income but at the
same time it should also be appropriate. If you buy car just for status symbol
and week end picnic then it may not be good for your financial health. Most of
the salaried people make this mistake. Business man can take car loan in the
name of firm and claim all the expenses including depreciation as business
expense.
Personal
Loan: This neither adds to your asset nor to your
income. This is mostly taken to meet
emergency needs. The rate of interest is also high ranging from 14% to 40% p.a.
One need to be very careful while taking personal loan.
Gold
Loan: This is the recent trend and people have started
taking loans on the security of gold heavily. Again this loan neither adds to
your asset nor to your income and is mostly taken to meet the emergency need.
The rate of interest is also very high ranging from 12% to 28% depending on the
ratio of the loan taken to the value of the gold offered as security. One needs
to be very careful while taking gold loan.
Consumer
Loan: Most of the people often take this loan for buying
electronics and furniture fixtures at the time of festivals or family
occasions. Again this also neither adds to your asset nor to your income.
Sometimes this loan is available with zero percent interest but this comes with
heavy processing fees and you have to pay minimum 2 EMIs while buying the
product in advance which increases your purchase cost which is nothing but
interest you pay on consumer loan.
So
any loan which either adds to asset like home or property loan or adds to your
income like education or car loan (in some cases) are good loans. But loan
which neither adds to asset nor to income are bad loans. Personal loans,
mortgage loan, gold loan, consumer loans or loan against credit card are prima
facie bad loans. One needs to take help
of a professional planner in case he is trapped in various loans.
This article is first appeared at myiris.com on 30th May'2012. below is the link.
