Loans – How to avoid debt trap

A loan is when you receive money from a friend, bank or financial institution in exchange for future payment of the principal along with interest.  The amount that is borrowed is called the principal and the interest is the amount charged for receiving the loan. Loans can be secured or unsecured. People usually prefer secured loans due to lower interest rates and also because a large amount of money is available which can be used to buy a car or a house. Unsecured loans are common in the form of personal loans. They carry a higher interest rate and are available in smaller amounts. 

There are mainly four types of loans,

1. Education/student loan
2. Home loan
3. Car loan
4. Loan for household items

Overall we can say that a loan gives one a right to pay as per his/her convenience subject to timely payment of instalments. A loan is a cheaper tool as compared to an overdraft or a credit card. When funds are raised through equity, the profits are shared with the shareholders. In case of a loan, no such obligation exists. The interest payable on the loan is a tax-deductible amount as per a few provisions of the Income Tax Act. The government also gives relief from the interest payable on various loans from time to time. 

At the same time for the newbees who want to start their own business, it is difficult to get finance as banks demand collateral.  Interest rates may depend upon the market sentiments and are subject to change. The amount of instalment too may vary depending on that. Loan afterall is a liability. It needs to be disposed of someday and calls for a disciplined payout every month or at a regular interval. 

Let’s understand each type of loan with its merits and demerits which can further help in taking a decision whether to take a particular type of loan or not.

1. Education Loan: All leading banks in India provide Education loan facility to students who want to attain their academic goals. The eligible courses etc are prescribed by the lending bank. The loan can be available at a fixed interest rate or a floating one. Before taking an educational loan you must know about the eligibility criteria and the necessary documents to get the approval at the earliest. Tax benefits can be availed under section 80C and 80E of the Income Tax Act. There are a few banks which are considered to be the best to offer education loans-

• HDFC Bank: The education loan that you can get is upto Rs.20 lakh and above for study in India and abroad. If you choose to study in India, it is limited upto Rs. 20 lakh. All the cost of studying abroad is covered under the foreign education loan without any cap. A fixed deposit or an immovable property will be required as a collateral in that case. The amount shall be disbursed directly to the institution imparting education depending upon the fee structure. The loan shall be available for a period of 15 years. The bank takes two to three days to process the loan application and disburse it. If you have a premium savings bank account or a good long standing relationship with the bank, then chances of your education loan getting approved are higher.The interest rates are low,  processing is quick but HDFC Bank takes up to 4% prepayment charges and 1% loan processing fee. It has a record of lesser loans for study in India. The bank doesn’t provide education loans for skill development courses and offers personal loans for it which is not a great idea due to the higher rate of interest involved. HDFC Bank’s education loan for Indian as well as foreign education is available at an interest rate of 9.25% to 13.68%.
• State Bank of India:SBI is considered to be one of the best banks offering education loans in India for foreign studies. Maximum loan amount is upto Rs. 1.50 crores under the SBI Global EdVantage scheme for foreign studies. SBI offers one of the lowest rates for education loans in India.The courses for which the loan is available are professional and technical degree, Certification courses conducted by CIMA-London and CPA-US,PG and diploma courses like MCA,MBA and MS from a reputed university. The SBI Scholar Loan Scheme is available only for merit students who want to study in IIT,IIM and NIT institutions. If you get a personal guarantee from a reputed person, it would be a perk while getting approval in your favour. 

Rates of interest are as given below-

• SBI student loan scheme @ 9.30%
• SBI scholar loan scheme @ 6.90% to 8.20%
• SBI skill loan scheme @ 8.80%
• SBI Global Ed vantage scheme @ 9.30%

Thus, the bank provides loans at as low as 9.30% rate of interest. There are different schemes available. There is no processing fees upto Rs.20 lakh. At the same time it charges high processing fees and 15% margin for studies abroad. 

• Punjab National Bank:The bank allows educational loans without any upper limit. But it takes into account your repayment capacity and margin. The following are the various schemes according to the type of degree/certificate

PNB Saraswati Scheme- It is available as an IBA model education loan scheme for meritorious students at up to 9.55% rate of interest.

PNB Pratibha Scheme- Available to students who want to pursue higher education in premier institutions like IIT. The applicable rate of interest is 6.90% to 7.55%.

PNB Kaushal is meant for vocational and skill development courses. The rate of interest on this type of loan is 8.30%.

PNB Udaan-For higher education in foreign countries and in reputed universities. Degree, PG like MCA,MS and MBA, CPA,CIMA and other diploma courses in aeronautical, pilot training and shipping.The rate of interest is 9.55% for such loans. 

In addition to the above there are area specific loans. PNB Honhaar is for Delhi based students and it is available at 8.95% interest rate. PNB Bihar Student Credit Card scheme is for Bihar based students. The bank has a Padho Pardesh subsidy scheme for minor communities for studying abroad. 

The following factors should be given weightage before you take an education loan-

• While choosing a course it should be remembered that an additional degree may not mean better job prospects. Selecting the right course is a must. Select a course which offers good job potential.
• Next mistake is to take the maximum loan available irrespective of the repayment capacity. Students should only take loans that can be repaid by their future salary. When you study in a good college and take up an MBA or B.tech course, the loan amount usually ranges from Rs.15-20 lakh. With at least 9-10% interest rates, the monthly instalment ranges from Rs.20,000-25,000 and above for a  minimum period of 7 years. If you compare this amount with your salary, which too will not be much above the amount of the loan taken, you will find it is not a worthwhile decision. 
• Moreover the fee is just one of the components of your expenses. You also spend a few more thousands each month as your personal expenses while studying. Considering all these hidden costs along with the cost of borrowal, you may not be even sure you will get a good job and earn enough to cover the expenses. 
• During all the years you pay your loan, you need support from your family over and above your employment and health status.There are many red flags before finalising a particular course. Merely because it is aided by some lending scheme, do not rush for it.

2. Home Loan: When a home loan is taken from a bank or any other lending company, usually the property is taken as a security for the home loan. The borrower has to pay back the loan amount with interest in Easy Monthly Instalments over a period of time ranging from 10-30 years. There are different types of home loans like Home Purchase Loan, Construction Loan, Land Purchase Loan, Home Improvement Loan and so on. Interest charged on home loans is tax deductible. However if a borrower fails to repay the loan, the bank or the financial institution retains the legal right to the property for which the loan is taken. Home buyers facilitate the purchase of a house by taking a loan. Home loans are an essential force in the real estate market too. Those with a good credit history will get loans easily and within two to three decades they will manage to pay off the loan. 

Here are a few suggestions that you may like to consider:

• SBI Max Gain: These loans are sanctioned as an Overdraft. The customers have to pay EMIs and the Drawing Power on the Overdraft gets reduced on a monthly basis to the extent of the principal component of the EMI so that the Overdraft is liquidated at the end of the loan tenure. This scheme is out of many schemes available with SBI. The following table shows the interest rates applicable depending upon the amount of loan taken-

The home for which the loan is given acts as a collateral. The rate of interest is a floating one. Advantages of this scheme include:

• The applicant can submit the necessary documents to get the account opened. There is no extra charge for it. However the account can be opened only if you take a home loan of at least Rs. 20 lakh.
• The deposited amount can be withdrawn at any time and can be used for a variety of purposes such as bill payments or other financial obligations.
•  It is a friendly product that allows the customers to earn optimal yield on their savings by reducing interest burden on home loans.
• The home loan account can be operated with flexibility just like a savings bank or a current account. The bank provides a Cheque Book, ATM cum Debit Card and Net Banking facility for this purpose.
• The money deposited in a Maxgain account would be tax-free. It is applicable to the amount equivalent to the home loan amount.
• ATM services make the withdrawal of cash from the account much easier. But if you withdraw cash from another bank’s ATM, it will be charged as an OD account.

The disadvantages of SBI Maxgain Home Loan are-

• The tax benefit would not serve much purpose if the investment is in excess of the home loan. As the benefit is limited to the extent of the amount of the home loan. 
• Not many know about this scheme. It is not easy for a common man to understand how the scheme works. 

If you want to get a Maxgain loan, you must submit the salary slips( in case of salaried individuals) and tax returns for the past two financial years so the bank can decide your financial standing. Otherwise the eligibility for a Maxgain account is the same as an SBI home loan eligibility.  

• Kotak Mahindra Bank:Kotak Mahindra Bank has made applying for a home loan very simple. By filling out your personal details in the form that appears online, you can get a quote. Once processed the home loan gets sanctioned within 24 hours. The bank offers in principle approval of the housing loan through a paperless process by using customer’s income tax credentials. Further to make the process easy the documents required are kept minimum. You have to provide proof for your address,age,identity, education and banking details. Depending upon your monthly income, qualification, work and credit history, age and number of dependents etc general criteria, the bank will determine your eligibility to apply for a housing loan. The interest rates start at 6.65%. 

Punjab & Sind Bank also offers home loans at lower interest rates. There are 16 banks and housing finance companies that offer Rs.75 lakh home loans at interest rates that are under 7 percent. You can check the rates charged by various banks.

The flip slide of a housing loan-

• It is advisable to invest in a property through a loan only if there is an appreciation in the value of the property. If the profit is higher than the net interest payable on home loan, then it’s a worthwhile investment. 
• Also if the rent from the property takes care of the EMI it is worth giving it a shot. But homes appreciate at varying levels. When a house is located in the centre of the city or near a prime area then it fetches a good value. 
• Appreciation depends upon a lot of factors. However, the property appreciation also hits a saturation after some time and at that point home loans are costlier than your own money. Again, in order to gain via value appreciation, we end up buying in a prime or a fast developing locality. 
• It is advantageous only when the rent that you may earn plus the tax advantage that you get is more than the cost of repayment. Sometimes it is better to get a rented house than owning one. You can use your money for some other alternative investment like equities in that case. 

3. Loans to buy depreciable assets: Car loans are the best example of depreciable assets. Manufacturing machines and equipment like computers and office buildings are also depreciable assets. The purpose for which you are buying a depreciable asset is crucial to decide whether funding the asset via a loan is appropriate or not. There are a few pros and cons associated with buying depreciable assets-

• The depreciable asset is helping to grow you financially after taking into account the interest charge and other costs pertaining to it, then you may consider it. Otherwise the same money could have a larger opportunity cost. 
• As per a few experts, borrowing money to pay for something that is for personal use which is also losing value, is not a worthwhile decision. Let’s think about buying a vehicle. Instead of buying a very expensive vehicle, especially a car, you can buy a vehicle of somewhat lesser value or considerably lesser value as it does the same job of transporting you from one place to another. 
• Whenever surplus money is left with you, try to pay off loans on depreciable assets like cars. As these loans carry a higher rate of interest than the home loan. So out of the two types of loans namely, car and home you should try to pay off the former one. 
• For a car loan there is no income tax benefit, that is another strong reason to pay it off whereas a home loan will be eligible for deduction section 80C and section 24. 
• A house in a nice locality will be an appreciating asset, unlike a car. A car also needs insurance and other running as well as maintenance costs. So the costs incurred to procure it might be higher. 

The Positive sides of buying a depreciable asset-

• The recent Covid situation has revealed the importance of owned vehicles including cars. People do not prefer using public transport and that has pushed car sales up. The convenience  and comfort of having one’s own car is unmatched under any emergency situation.
• Machinery and other equipment used to run a factory etc are depreciable and needed for manufacturing or production processes. They are inevitable and reflect as  the assets of the business. The depreciation can be claimed as an expense in the books of accounts. 

While applying for both car loans and other depreciable assets, a good credit score is needed. Lower rates of interest can be offered by the lenders only when your credit rating is good. No security or collateral is needed other than the asset itself. 

For all individuals aged between 18-75 years car loan is eligible. Minimum net monthly income should be Rs.20,000. At least one year of employment is needed with the current employer. Both salaried and self employed individuals must be working for a government establishment or a private company.  The following are the best car loan products ranging from 6.50%-7.50%.

A car is only worth what it can give you. Any other depreciable asset that you purchase should offer some advantage out of buying it. There are many lending banks providing loans for machineries and other equipment depending upon the scale and type of the industry. 

4. Loan for consumer durables: If you can buy a consumer durable without taking a loan or using a credit card, it would be better. This holds true because of many reasons such as,

• The sellers of consumer durables expect to grow the demand by offering zero interest loans. All of these items are depreciable and meant for personal use. There should be some logical reason while buying it. The period for which it will be used also matters.  They should be worth spending for the comfort you want keeping your income in mind.
• All these are upfront expenses and have a limited lifetime. They fetch very less resale value. If you have a habit of changing your gadgets frequently, it will surely impact your savings when your earnings are not very high. 
• When you are a salaried person and no tax deduction is permissible for such durables, you should think reasonably about how to spend your post tax income. For businessmen and professionals charging expenses against their income is still possible. 

Should a loan be taken for consumer durables?

Every loan comes with an interest cost. Paying for a durable item over a period of time looks attractive, many fall for the trap. A ‘zero interest’ loan is nothing but a disguised form of a cleverly offered loan. Usually such loans require an administrative fee, which is nothing but the amount of interest. A few instalments are to be paid in advance. Hence the effective loan amount is lower. Look at other options to fund your purchases. For an example loan against your FD at a lower rate. 

Again, when you use your credit card to make such purchases and pay the balance over a period of time, then it will be the costliest option. If you use a credit card for buying a consumer durable, you end up paying a high rate of interest. Carrying  this balance from month to month will cost you more. Missing any payment cycle will impact your credit rating. It is easy to get carried away with the credit card but such habits lend you into a debt that is beyond your means sometimes to pay off. There are credit card charges, other fees which may be added to the cost of using  this facility. Many credit card frauds have come up recently due to the forced online purchases that people had to make during Covid times. Always think about the opportunity cost of buying something by taking a loan and thereby paying interest and other charges. Be careful of such deals as they may be pertaining to the goods, value or demand of which are falling due to the introduction of a new model .

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Krishna Rath is a SEBI Registered Investment Adviser, and since 2015 has been educating netizens on investments and insurance. Krishna is a fee only SEBI RIA and is Odisha's first SEBI RIA. With background in IT, Krishna is changing the advisory space with new innovations in AdvisoryTech.

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