Life on a bank loan

Nowadays a bank loan has become a faithful companion almost to every family if not every individual.
Life on a bank loan
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Nowadays a bank loan has become a faithful companion almost to every family if not every individual.

The kind of fast growing consumerism coupled with emerging sea of personal needs has forced almost all segments of population, especially the young generation to embrace life on a bank loan. Or we can easily vouch that loans have now started shaping the way of life to realize growing aspirations.

In fact, availability of hassle free loan schemes matching even to the individual requirements of the borrowers coupled with minimum formalities to comply with and super fast appraisals has been a motivating factor for the people to rest their prosperity on the bank loans. Thanks to the integration of information technology into the banking system which has created credible shortcuts to reach to a desired loan scheme and avail the benefits. One of the major changes has been that now societies don't recognise a bank loan as a stigma.

However, in today's context, it's the convenience granted to the customer to obtain a loan which pulls crowd at bank loan counters and not the cost of loan which includes its interest component, loan processing fee etc. So, while turning a blind eye to the cost of loan, it may sometimes be breeding stress. In majority cases, a loan brings peace, prosperity and profits to the borrowers, subject to the condition the borrowers remain faithful and honest in their dealings.

So availability of finances at affordable terms and conditions has upgraded the living standard of the individual borrowers and ultimately the society. Notably, utilizing the bank loan for the activity it has been obtained translates into growth of money. Contrary to this, any diversion of loan amount will result in low economic activity and threat always looms large that loan repayment may get hampered. And in conditions when borrower fails to deposit EMI (monthly Equated Installment) on time, a loan then only breeds stress.

One of the major components of a loan is the rate of interest at which it's made available to a borrower. Mishandling of this component has devastating effects on the 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). Let me explain. Suppose you have taken a home loan of Rs.20 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.

So the question is how to reduce the burden of interest on loans? The answer lies in the deposit schemes. It would be in the fitness of things if a borrower takes route of a bank term deposit scheme or invest in financial instruments like mutual funds etc. available in the capital market.

For example, if you simultaneously invest Rs 1000 monthly in a SIP and continue it for the tenure of the home loan repayment schedule, you will be principally investing Rs.2.40 lacs and getting an amount of over Rs. 14 lacs at the end of 20 years with return of 15% per annum. The rate of interest may vary, but the point is that you can 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 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.

Precisely, the power of a bank loan has two sides. It can either bring prosperity to you or leave you in a debt trap.

(The views are of the author & not the institution he works for)

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