True cost of Personal Loans

A friend of mine took a personal loan from Citibank of value INR 1.1MM (11 Lakhs) but decided 12 hours later that he does not need it. To his surprise, he discovered that the cost of cancelling the loan was 80k. Here is how:
1. 1% processing Fee: 11,000/-
2. Payments for 6 months @30,614 p.m. = 1,83,683/- (4 years tenure)
3. 2% Pre-payment penalty: 19.912/-
4. Principal Left after 6 months 9,95,602/-
Total Payments: 12,10,197/- or a loss of 1,10,197/-
Of this he is able to recoup 30,373/- by reinvesting in a 6% FD of the same bank. This reduces the total loss to 79,824/- (or 7.26% of the borrowed sum)
I have always advised people to either borrow from friends/relatives or take a bank overdraft. Because there 15% interest means 15% and you will never have situations where you end up paying 7-8% for a couple of hours. Remember banks are predators who pose as friends.

education Personal Finance

Do you need personal loans?

Note: This article is meant for people with a steady source of regular income and a salaried bank account. Also the person is able to save more than 20-30% of his salary.
The top five reasons why Indians take a personal loan are:

  1. Medical emergency,
  2. Travel,
  3. Wedding,
  4. Investment (esp. stock market and speculative property investments),
  5. Helping a relatives and family.

And debt consolidation: Some people also use it to refinance their Credit Card dues or loans from informal sources. But in that case, one would realize sooner if not later that it was an expensive decision.
Most personal loans have 3 clauses –

  1. A regular EMI for the entire duration of the loan 6-24 months
  2. Processing fee from 2-4%
  3. Restrictions on prepayment. I.e. one cannot prepay in the first 3-6 months and not more than 50% of the loan balance outstanding in one payment.

These Terms and conditions often don’t match with the optimal debt repayment schedule for the individual. Hence given a choice, I always discourage people from taking a personal loan.
1. Bank overdraft: This is the easiest and the cheapest option for short term credit. If you have a salaried account, then just ask your bank and they would be more than willing to give you a generous 1-2L line of credit which you can repay at ease. Charges like account opening charges, commitment fee (0.25-0.5% of the line of credit) may look like a lot, but due to flexibility in repayment, the overall interest expense is much lower.
2. Credit Card: If you search the archives of enagar, you will find reference to an older article which tells you how one can draw money equal to the credit limit (which is higher than the cash limit) for 50 days at a cost of 3% (paid upfront) and 1.8% for subsequent months.
3. CrowdSourcing: Why do to an institution in the first place. Go online, dial a friend and fund yourself. P2P loans are cheaper, faster and simpler than most bank loans.