Loan against deposits

Believe it or not! It’s true. A survey report by Home Credit India, a local arm of the international consumer finance provider with operations spanning over Europe and Asia revealed that nearly half of Indians have primarily depended upon borrowed money to run their households during the ongoing COVID-19 pandemic. With job losses and pay cuts across industries, the lower middle-income group has been affected severely and the pandemic has led to a shift in perspective towards loans and borrowing preferences, said the report, which hit news headlines just few days back.

It’s pertinent to mention that uncontrolled outbreak of COVID-19 pandemic has devastated financial resources of majority of households and they continue to struggle with finances to run their domestic kitchens. Here the households have been banking upon borrowed money to keep their kitchen budgets afloat during this unprecedented COVID-induced financial crisis. 

Over a period of time, a bank loan has become a faithful companion to individuals as well as families. Instances galore narrating those loans extensively used, particularly by the younger generation, to realize their growing aspirations. But, this time the scenario is different. Households need money to stay afloat in day to day affairs, especially the domestic affairs consisting of mostly essential needs. And most of the people are struggling on financial front as the pandemic is eating up their savings too. Those taking route of borrowings are straight way stressed to ensure the borrowed money, especially bank loan, is repaid without any delay as the stability in income has already been at stake due to COVID crisis.

Even as banks run many loan schemes to fund varied needs of their customers, there’s a facility for depositors in the banking system where they can obtain loan against their own money and that too in a most hassle free manner. It’s a very common sight in bank branches where depositors in need of cash on short term basis to meet their exigencies are lined up to break their fixed deposits (FD) before maturity. Notably, withdrawing money from a fixed deposit (FD) before maturity is known as breaking an FD. When you break the FD, you get a lower rate of interest and also pay a penalty for the premature withdrawal. For example, you opened a 1 years FD at 7.5%. If you decide to break the FD at 10 months, the interest earned on the FD will reduced by 1%.

However, there is a solution for such depositors to meet their immediate cash requirements without breaking their FDs. Meanwhile, in the given COVID crisis when domestic budgets are under extreme stress for lack of appropriate financial resources which have dwindled due to loss of jobs and fall in income, banking upon borrowings and bank loans demands a cautious approach. Otherwise chances are falling into a debt trap. So, in the backdrop of above discussed scenario, let us have a look at various aspects so that households or individuals take route of borrowings or bank loans judiciously.

What precautious should be taken while take route of borrowing or bank loans?

The most important thing you should concentrate on while boarding on loan platform is 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 your repayment capacity.

One more thing, while taking a loan you should have a thorough look at its cost – the interest rate at which it’s 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.

Let me also aware you that there are many loan schemes especially in personal segment where a borrower ends up paying more than double the amount of loan (principal amount). For example, you have taken a home loan of Rs.10 lacs and your repayment along with interest of 9.50% runs through 20 years. That means your equated monthly installment is Rs9321. After 20 years of repayment in EMIs you repay over Rs22 lacs, meaning thereby that you have paid over Rs 12 lacs as interest.

You can reduce the burden if you try to get your interest rate on loan reduced. Or you can take route of saving instrument to lessen your loan burden substantially even in the event of sluggish interest rate on deposits.

Meanwhile, let me share some important tips which you should follow while obtaining a bank loan. Ensure total EMI of your loans remains within the range of 35 to 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.

What is loan against term deposit scheme?

It’s one of the oldest banking practices that when you invest in a bank fixed deposit, you can easily get a loan against it without having to break it. It’s as good as a personal loan and you don’t need to state reasons for obtaining this loan which is disbursed as an Overdraft facility against your fixed deposits.

How much one can borrow against these FDs?

Quantum of finance depends upon the amount parked in these FD instruments. Normally, banks offer a loan anywhere between 75 and 90 per cent of the deposit (principle as well as interest accrued). 10-25 per cent is maintained as margin. However, the percentage may vary from bank to bank.

How much interest is charged on these loans?

This is the most convenient and cheapest way of obtaining a loan. The interest on such loans is charged on the amount drawn and not the limit set. Rate of interest varies from case to case. Normally, it is charged 2 to 2.5 per cent over the rate paid by the bank on your fixed deposit instrument. Some banks charge only one per cent over the rate paid on your FD.

For instance, you have a fixed deposit of Rs 2 lakhs earning an interest of 10.5 per cent a year. At 25 per cent margin, your overdraft limit is set at Rs 1,50,000. You can withdraw the amount at your will in one go or in installments. The interest would be charged only on the amount withdrawn not on the set limit of Rs 1,50,000.

What is the tenure of the loan?

The tenure of the loan, or we can say repayment schedule of such loan is directly related to the period of deposit. In other words, there is no specific tenure fixed for the repayment of the loan and you can avail of the loan till the FD, against which you have raised the loan, matures. However, during the repayment schedule, you are at liberty to repay it or not. If the loan remains unpaid till maturity of the FD, the loan along with interest is adjusted against your fixed deposit proceeds. No other charges/fees are charged in such loans.

Is there any tax benefit in such loans?

If you are running a business, you can seek help of your financial consultant to derive tax benefit out of such loans. For example, as stated by a tax consultant, the interest paid on loans raised against deposits by a businessman or a self-employed individual can be included in the books as business expense from their business income. The condition is that the amount of loan raised is invested in the business.

Meanwhile, those who have invested in post office time deposit instrument, they can also avail loan against the said deposit from some banks at the time of need. However, the percentage of loan against the said deposit would be less than the bank FD instrument.