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How to get the best from a personal loan

Larissa Fernand

Neither a borrower nor a lender be... for a loan oft loses itself as well as a friend in the giving.
Polonius, in Hamlet

Probably this was the reason that banks decided to come out with the personal loan. When buying a house, there is always a housing loan to fall back on. If its a car, there is the auto loan and so on and so forth. But what if you want a loan for a wedding or holiday? Instead of tapping the pockets of family or friends, might as well opt for a personal loan. The popularity of this loan stems from the fact that you don't have to state the reason why you need the money. The icing on the cake: neither do you have to produce any collateral as in the case of mortgaging your home. What more could you ask for?

How to get the best from the loan
There are two very enticing reasons for taking a personal loan. One is that you can put the money to any use you deem fit, be it to finance a holiday, a wedding or even studies. The discretion is yours totally and you don't have to state the reason. Interestingly, if you are in debt, you can utilize this loan to your advantage. There are two ways by which you can do so.

One is to use it for refinancing debt. Assume you have revolving credit on your credit card at the rate of 2 per cent per month. This amounts to 24 per cent per annum. What's more, every single item that you purchase and every expenditure billed onto your card is subject to this rate of interest. So now you don't get any free credit. You are paying the bank to use their funds which you eventually have to repay. You can opt for the personal loan and clear all your credit card outstandings. You will be paying less to service your loan and you can once again avail of interest-free credit.

The next option is if you are heavily into debt and that too from a variety of sources. You could be servicing a consumer durable loan, revolving credit on your card and probably even taken an overdraft on your bank deposit. Instead of servicing the debt at different rates of interest with different repayment tenures, it makes sense to consolidate it into one single source. You will find that you are in a position to manage your finances much better. But, whether or not you end up paying more by way of interest, depends on where you have taken the loan from. To determine this, calculate how much of money you will need to repay all your loans. Present this figure to the bank and ask them how much the equated monthly installment (EMI) will be on such a loan, the repayment tenure should be around the maximum time you think you will pay off your current loans. If the EMI is way above what you are paying now, the personal loan will be an expensive proposition, despite the convenience.

Demystifying the EMI
The equated monthly installment is term used for the money that you will have to pay every month to the bank. Since you will be paying one installment every month, the 12 installments at the end of the year are referred to as equated annual installment (EAI).

When you and the bank decide on the loan amount and the repayment tenure, the EMI is fixed for this time frame. Though it is an unequal combination of principal repayment and interest cost, it remains constant all through. The EMI payments at the start of the loan are heavily tilted towards interest payments and principal repayments are towards the end of the loan tenure. Hence, you end up paying more since the principal gets repaid only at the end of the tenure.

The rate of interest will be calculated either on a monthly reducing basis or on an annual reducing basis. Monthly reducing basis means that principal amount you pay every month is deducted when calculating the interest rate for the following months. Annual reducing basis means that the total principal repaid by the end of the year is deducted when calculating the interest rate for the next year.

Calculations on loans are also done on a daily reducing balance. But this is mainly done on credit cards whereby whenever a payment is made, the principal is immediately deducted. So if the payment is made on January 15, the interest rate adjustment takes effect from the very next day. In the case of monthly reducing balance, it takes place the next month and in the case of annual reducing basis, the next year.

The most expensive loan will be one which is calculated on a flat rate of interest, though its interest will appear the least. Don't get fooled. For example, if you take a loan of Rs 85,000 to be repaid within two years, the bank may quote a flat rate of interest at 9 per cent. On an annual reducing basis, it would work out to 11.77 per cent and 16.41 per cent on a monthly reducing basis.

So when presented with a rate of interest, ask them the method of computation. The thumb rule: the more frequently computed the better.

What will you need to qualify?
Not much. For starters, there is no collateral needed. The crux here is to provide the right documentation. You will need to produce the latest salary slip, proof of personal identity (passport, driving license, voter identity), income tax returns, six month bank statement and credit card statement (if in possession of one). What's more, the company you work for should be on the bank's approved list. Each bank has its own set of criteria. Some may consider applications only from listed companies. Others may look at private companies with a specific turnover. Multinationals are generally approved of. So before you even submit the documentation, you will be asked the name of the company. This will determine whether or not they are interested in you as a prospective customer.

How much of a loan can you expect?
Besides your personal criteria (income, age, dependents, servicing of any other loan) being the determining factor, each player has its own specifications. Standard Chartered Bank, for example, offers four times the monthly salary for one-year loan. It increases to eight times the monthly salary for a two-year loan, 11 times for a three-year loan and 13 times for a four-year loan.Citibank offers it for 11 times the monthly income salary and ANZ Grindlays Bank subjects its EMI to a maximum of 40 per cent of net monthly salary.

Repayment will depend on the amount of loan in some cases. It is fixed at five years for ANZ Grindlays Bank but three years for Citibank if the loan is up to Rs 1,00,000. For higher amounts it is four years. At Standard Chartered Bank, it is two years for amounts up to Rs 1,00,000 and for other amounts it goes up to four years.