Bank loans: Handle with care

Covid-19 crisis has squeezed the financial resources of one and all – be it an individual, households or companies. Even the pandemic-induced crisis has wiped out savings of majority of households and has left them with financial crunch. Uncontrolled mounting prices of essentials such as vegetables, groceries and transport have grossly dented the spending capabilities of the households. They have been dealing with job losses, reduced or total loss of income triggered by the Covid crisis.

The impact of the crisis is still refusing to die down despite economic recovery in post pandemic-induced lockdowns. The soaring of both retail and wholesale inflation which was recorded at 5% & 4.2% respectively in February has unsettled the domestic budgets.

The surge in prices of commodities and other costs is proving a termite on peoples’ savings, as they are forced to lay hand on their savings to foot the bills of essentials in the absence of appropriate income sources. Even, they are prompted to reduce expenses on certain activities of which they were accustomed in the pre-Covid times.
Precisely, we are witnessing never-seen-before changes in our social set-up and people have no option but to fall in line with the changing times, courtesy Covid-19 virus. Whatever the nature of changes taking place around us, there is a common force pushing these changes to the grass root level. This common force has its might in finances.

So, availability of finance holds key for people to keep themselves afloat in the given circumstances. When it comes to availability of finance, the resources for larger part of the societies are bank loans. Even as living on a bank loan was already a norm in the pre-Covid times owing to fast growing consumerism coupled with sea of personal needs, the bank loan is now assumed as good as oxygen by individuals, families and companies to brave the financial crisis and remain economically afloat. The crisis has forced the people to take route of loan schemes and live on EMIs (Equated Monthly Installments). Now people think EMI, eat EMI and breathe EMI.

In the given crisis, it has been observed those who want access to cash take route of loan schemes without evaluating the cost at which the loan is made available to them. Most of them don’t weigh the option while accessing a loan scheme.  There are certain basic things which are important to understand before approaching a bank for a loan facility. Currently, most of the financial needs are emergency in nature as the funds are required for short term to negotiate the impact of pandemic-induced financial crisis. Even as there are various schemes in the loan basket of banks, it’s the gold loan scheme which has witnessed a huge surge during the pandemic crisis.

A data reveals that till January, there has been meager growth of 5.7% in banks’ credit portfolio over the previous year. The growth in retail loans has slowed down to 9.1 per cent year-on-year in January against 16.9 per cent a year ago. But loan against gold has witnessed a remarkable growth of over 130 per cent growth, zooming to portfolio of Rs.43,000 crore from Rs.18,500 crore, during this period.

What are the precautions to be taken while accessing a loan scheme?

Affordability of the burden of a loan is the first thing to be self-assessed before approaching a bank for a loan facility. Here you have to understand that affording a loan is different from EMI affordability. You may be able to afford an EMI for a few months or some years but not the actual Loan. For paying an EMI on long term basis, you are ignoring future needs.  You may consider increase in your future income, but then unprecedented crisis like the Covid-19 pandemic, rising inflation and other added expenses over a period of time will simply be adding to your financial burden. One more thing is that you may afford higher EMI today, but this way you would be having lesser chances of savings for your future. Needless to mention that over a period of time you would be loaded with more responsibilities in life and to shoulder them savings for future is a must.

You must understand that when you purchase something on EMI, it may be for immediate gains, but at the end you pay for a period of prolonged pain. These EMIs, of course, help you to have goods that you might not have been able to otherwise afford – from kitchen appliances and washing machines, to luxurious cars and high-end electronic gadgets, including smartphones, tablets and LED TVs, etc. But these  consumer goods are essentially depreciating assets and you are paying more for something that is fast losing its value, and paying more for it over the long run.

So while opting for loans, it always necessary to look beyond the initial years and calculate the potential impact, those EMI payments will have on your future financial life. It is just a matter of good financial planning.

So, what are important tips you should follow while obtaining a bank loan?

Ensure total EMI of your loans remains below 40 per cent of your take home salary. Examples galore which suggest that anything outside this range puts a borrower into a debt trap. Don’t get lured to small/affordable EMIs. Always remember that your monthly budget and cash flow position is always changeable under the circumstances of repaying a bank loan. Check you net income (inflow) and expenditure (outflow) and the difference between the two will give you the quantum of your cash reserve. This cash reserve figure is the actual empowerment you possess to decide the amount of loan you can obtain and repay without any default.

In simpler terms, you have to ensure that your borrowing is prudent and need based. You should not err into borrowing just because loans are easily available. Too much of borrowing can leave you in difficulty in repaying a loan. It’s important for you to consider your income before raising a loan. Never go beyond you repayment capacity.

Don’t overlook the cost at which a loan is available. It’s a usual scene at a bank branch that a borrower gets influenced through easy access to the loan facility and hardly negotiates rate of interest with his banker. Otherwise, one of the major components of a loan is the rate of interest at which it’s made available to a borrower.

There are many loan schemes especially in personal segment where a borrower ends up paying more than double the amount of loan (principal amount).

How convenient are gold loans? When should one bank upon such loans?

Gold loans are easily accessible to all. These are  hassle free in terms of eligibility criteria, which is minimum. In fact, the only criterion is that you must own gold against which the bank would be lending you money.  Its sanction and disbursal is quick and is not linked to your credit score unlike in other loan schemes. It carries relatively lower rate of interest than loans like personal loans. Notably, the bank won’t evaluate your repayment capacity while giving a loan against your gold.

These loans could help you in managing liquidity needs faster than any other loan instrument. And is the best rescue route during a financial emergency.

Precisely, such loans can help small businesses to tide over the temporary cash issues, or someone who needs emergency money, or if an individual plans to consolidate debt.

Remember,  opt for gold loan only when you are facing a temporary cash-flow problem. Don’t use it to fund a big expense, like buying a house. Keep the tenure as short as possible.

What’s the current scenario?

Market statistics reveal that following the coronavirus outbreak, small businesses and individuals borrowed ( and are borrowing) heavily against the yellow metal to negotiate their cash flow problems. This unprecedented demand put the gold loan industry on a growth curve. Due to the inherent benefits of gold loan and the prevailing economic scenario, the gold loan sector is seeing strong demand and disbursal growth.

How is gold loan repaid?

Gold loans can be repaid in multiple ways.  It depends upon your choice. For example, you can repay in EMIs, or you can choose the option of paying interest during the loan tenure and one-time principal payment at the end.

What happens if gold loan is not paid back?

There are two important things to remember. If you fail to repay the loan on time, the bank has the right to sell your gold. Meanwhile, during the currency of the loan, if gold price falls, the bank may ask you to pledge additional gold to maintain the loan to value (LTV) ratio.  Loan-to-value ratio is the value of the gold the bank holds. It should be more than the money disburse d by the bank.