With the wide variety of credit options available to borrowers today, borrowing money is becoming increasingly popular. There are different types of loans borrowers can choose from depending on their needs, including personal loans, home equity loans, car loans, and others. Lenders today even offer instant loans that take as quick as five minutes to get disbursed. Repayment, on the other hand, is a completely different story. When it comes to choosing a loan, there are some factors that you should consider which makes loan repayment simpler and more efficient.
Borrowers opt for loans for various reasons. They often take different types of loans for the purchase of property or vehicle, construction, education, setting up and running a business, and so on. Personal loans are usually used to address the more immediate needs of the borrower, such as weddings, travel, and medical emergencies. People have been using them for a variety of purposes — from consolidating their debts to avoiding bankruptcy or paying for unexpected expenses.
Loans are a popular option for borrowers because the interest rates are very favourable today. These days, they are also becoming easier to apply for, which means they get to avoid the lengthy application process. Borrowers today have access to a variety of repayment plans, which can be beneficial to those who have irregular incomes or unpredictable expenses.
Whatever be the nature of the loan, borrowers need to understand the key terminologies associated with lending.
Your interest rates are a portion of the loan repayment amount that you pay to the lender as an incentive for borrowing money. Interest rates are calculated every year and they depend on the type of loan and its term. The rate is usually expressed as a percentage, so it can be easily understood. Some lenders offer interest rates that are fixed for the entire term of the loan, while others provide an initial low-interest rate and then make it variable or market-linked.
The processing fee is the money that a lender charges for administrative costs, such as underwriting and processing the loan application. Lenders are allowed to charge this fee because it covers the cost of running their business. Processing fees are sometimes negotiable and can vary depending on the type of loan you apply for. Some lenders may have a flat fee while others may charge a small percentage of the loan amount.
A lender’s repayment policy is a set of rules that establishes the terms of repayment of a loan. These policies can be quite complicated and may vary depending on the type of loan and the lender. Hence it is always wise to read them thoroughly before deciding to avail the loan.
The most common types of loans are secured loans, where some collateral needs to be presented to cover the risk of you not paying back. The collateral for a secured loan can include property, stocks, or other assets that can be used to repay the debt if you default on payments. Unsecured loans are those given with no collateral. The interest rate for an unsecured loan will typically be higher than that for a secured one because there is no collateral to offset any potential losses in case of default.
When you apply for a loan, the lender will ask you to specify the term or tenure of the loan. The term is the period of time in which you will have to repay your loan. The term can be expressed in years, months, weeks, or days depending on the lender’s requirements and your preferences.
Loan amortization is the breakup of payments that are made to pay down the principal and interest on a loan. The payments will vary depending on the type of loan you have. The payment schedule for an amortizing loan will be fixed and is determined by the amount borrowed, the interest rate, and the length of time over which it was borrowed.
A credit score is a number that indicates the creditworthiness of a person. A credit score is usually based on a statistical analysis of your past borrowing and repayment history. The higher the score, the better the chance of approval for new loans or lines of credit.
Increase In the Policy Rate and Its Implications On Borrowers
Another concept borrowers need to know about, which can also affect their interest rates, is the policy rate. Policy rates are interest rates specified by the Central Bank of the country. For instance, the Repo rate is the rate at which banks of a country borrow money from the central bank.
Why is this important?
In May 2022, The Reserve Bank of India (RBI) raised the repo rate by 40 basis points (100 basis points is 1%). This is the first-rate hike in more than four years. The RBI has increased the repo rate to curb inflationary pressures. The move will also help protect the Indian rupee from depreciating further against the dollar.
Repo rate revisions are not very frequent. However, any increase in the repo rate will have implications on borrowers as it will increase their cost of loans and drive up their EMIs. Only floating rate loans will be affected by the change.
Why Do Borrowers Incur High Interest Rates?
Interest rates are the cost of borrowing money. They are typically expressed as a percentage of the amount borrowed, and they are paid in addition to the principal amount. The interest rate is what makes borrowing money expensive or cheap.
Interest rates are an important factor to consider when applying for a loan. There are many reasons why the interest rates may be high, and they can be a result of the risk associated with the borrower.
The interest rates on loans can also vary depending on the type of loans, such as secured or unsecured, and who is providing it, such as a bank or any other lender.
Interest payable on loans can sometimes balloon up suddenly when borrowers are not able to keep up with their monthly payments. For example, a person who takes a personal loan for a wedding and does not pay back on time, eventually ends up paying back at a higher interest rate on the overall outstanding as a penalty.
How To Choose and Structure Your Loan Efficiently
The first and foremost thing to do is to find a loan that has a low-interest rate. This will help you save money in the long run and keep your finances in order. When choosing a loan type, you can bear the following factors in mind:
Consider Multiple Lenders
You can consider taking a loan from new-age fintechs along with typical banks or financial institutions, depending on who offers loans at a lower interest rate.
Employee Provident Fund (EPFO)
One option is withdrawing from the retirement corpus maintained with the EPFO. There is no repayment required as it is from one’s balance, but keep in mind that you are dipping into your retirement corpus and this should be done only as an extreme step.
Public Provident Fund (PPF)
The PPF is a retirement product that has been designed to offer tax benefits as well as provide an avenue for long-term savings. You can avail of a personal loan against the balance held in the PPF account between the 3rd to 6th year after opening the account and start withdrawing partially from the 7th year onwards. Loans taken against PPF come at a very low-interest rate (1% above PPF rate) and with a repayment tenure of 3 years.
Gold or Property Loans
Taking a gold loan is an excellent way to get money for emergencies. Gold loans are short-term loans, which are repaid in installments over a period of time or at one go at the end of the tenure. They are typically offered by banks and other financing institutions which take gold as collateral. They offer a lower interest rate than most other types of loans as the underlying asset, gold, is highly liquid.
People often take loans against their fixed deposits. This is a way to temporarily tide over cash crunches without having to break a long-term deposit and lose the interest-earning opportunity. The interest on such loans is a small premium over the FD interest rate.
Insurance can be used as collateral to take a loan. If you take a loan against your insurance policy, the interest rate will be lower than if you took a loan against your house. But the downside of this is that your insurance policy will have to be with an insurer who allows loans against their policies and has a good credit rating.
Structure Your Repayment Process
The next thing to do is to structure your loan and bring discipline into the repayment process. This includes addressing the below factors:
Set up an automatic payment
Auto debit is a convenient way to have your loan interest paid automatically. You can set up auto debit through the bank’s online banking or mobile app. You can also set up auto-debit by contacting your loan provider. However, keep in mind that in the event of an insufficient balance in the account on the debit date, you will be charged a heavy penalty.
Consolidate your higher interest loans
When you consolidate your higher-interest loans to one new loan to lower your interest rate, you can get rid of all the fees and other overheads that come with having multiple loans. This can help you save money on monthly payments through a lower interest rate.
Borrow as per your needs
Borrowers need to plan their expenses and income in advance so that they don’t borrow when they don’t need to. They can make a list of all their expenses and keep track of them so that they know what their monthly repayments are going towards. A great tip is to pay off credit cards in full, before the due date, as much as possible because most credit card companies charge high-interest rates on overdue accounts.
Evaluate cash flows
Cash flows are the most important factor when deciding on loan tenure. The borrower should evaluate their cash flows before they commit the loan tenure, interest rates, and so on. This will ensure that they don’t get into a debt trap and can repay the loan easily in time.
A line of credit or loan can be a great way to help you reach your financial goals, but it’s important to understand the risks before you sign on the dotted line. The first thing borrowers need to think about is whether they can afford their principal repayments and interest payments. If not, they should consider other ways to meet their financial needs.
They should also think about how long they’ll need the money. A loan with a shorter term may result in lesser interest outgo than one with a longer-term, but it also means that borrowers will have that much lesser time to fully pay back. Finally, borrowers can find out if they are eligible for any government programs or schemes through which they could avail of loans at lower interest rates and pay off their debt faster.