The biggest complaint of loan consumers in India who have taken loans on a floating rate has been that lenders are quick to raise rates for them when interest rates rise in the market but are very reluctant to reduce their interest rates when market interest rates drop. Till June 30, 2010 the floating rate products were priced with reference to their Benchmark Prime Lending Rate (BPLR). Clearly the BPLR system was not functioning in a transparent manner. After setting up a committee to examine the issue and a draft note inviting public suggestions the guidelines relating to the new “Base Rate” system have been made effective for all loans issued or renewed on or after July 1, 2010. So will this new Base Rate system be effective?

This article examines the difference between BPLR and Base Rate regime and the potential impact of the Base Rate system.

The rate is “to be computed taking into consideration (i) cost of funds; (ii) operational expenses; and (ii) a minimum margin to cover regulatory requirements of provisioning and capital charge, and profit margin”. No this RBI pronouncement is not about the Base Rate but about the Benchmark PLR. If you see the non-binding “illustrative methodology” for the Computation of the Base Rate in the guidelines, it also more or less lays out the same set of parameters but just in greater detail.

So if the calculation method is similar how will Base Rate system make a significant difference?

For starters there are two big differences. Whilst each bank can choose its own benchmark for the cost of funds they will have to document the detailed formula for the calculation of the “Base Rate” and the method of calculation and follow it consistently (except during a brief six month transition period). This formula will need to be disclosed to RBI, which can also scrutinize that it is being followed consistently. This is unlike the BPLR regime where the BPLR was supposed to take into account the same set of parameters but no documentation was required and it was not open to RBI scrutiny. This is a significant difference between the two regimes since this forces the banks to follow a consistent method of calculating the Base Rate unlike the BPLR.

The second big difference is that, unlike the BPLR, banks are not allowed to lend below the Base Rate (again there are a few exceptions but they are not very relevant for this purpose). Now we all know that blue chip corporates are always able to get good rates from the banks. They are likely to be borrowing at interest rates very close to the banks’ current Base Rates. When market interest rates fall they will naturally expect to get better rates and naturally the banks will be forced to drop their Base Rates if they still want to maintain their share of this market. So apart from the point mentioned in the first paragraph, this factor will also exert downward pressure on the Base Rate when market interest rates fall.

If the transparency is so built in then why the doubt on whether the Base Rate system will be effective or not? Clearly the Base rate system is designed to be more transparent than BPLR. But unfortunately there is no requirement that the detailed formula of each bank’s Base Rate be made public (it is only to be available for review and scrutiny by RBI). Clearly RBI will need to set up a machinery to monitor and review these calculations to ensure that they are consistent, which given their focus on ensuring transparency is likely to function as an effective check on the proper implementation of the Base Rate system. It would be very interesting to find out whether the general public under RTI can access a specific bank’s calculation of Base Rate that is available with RBI.

As is likely the effective functioning of the Base Rate regime will significantly change the retail lending industry in India. Firstly as changes in the effective interest rate for the customer will depend on the “average” cost of funds rather than the “marginal” cost of funds any increases in market rates will take time before they are fully passed on to the borrower (see box for difference between “average” and “marginal” cost of funds). Whilst this is beneficial when interest rates increase it is also not so bad when interest rates decrease as, unlike the current situation, the consumer is likely to get some decrease immediately compared to none or very little in the current scenario.

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Difference between average and marginal cost of funds

Assume a bank currently has funds of Rs. 100 crores at an average cost of 10% (total cost of funds is Rs. 10 crores or Rs. 2.50 crores per quarter). Now the cost of funds in the market goes up by 1% pa. On an arithmetic basis the banks cost of funds should go up by Rs. 1 crore per annum or Rs. 25 lacs per quarter. However since a lot of the bank’s funds are in time deposits which are at a fixed cost - where the cost will rise only when the deposit comes up for renewal - immediately its cost may go up by only say 12.50 lacs for this quarter or only 0.50% p.a. Of course over a period of time as all the fixed deposits mature and are renewed at new higher rates the cost of funds will go up to Rs. 11 crore per annum or 2.75 crores per quarter). Thus the average cost -10% in this example changing to 10.50% or a change of 0.50% only - will always change slower than the marginal cost - +1% in this example)

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If you have an existing loan should you shift to the new Base rate regime?

Firstly there is no automatic shift to the new regime. You will have to ask your bank to shift you to the new Base rate regime for which they are not supposed to charge you any fees. If you are on an existing fixed rate loans (or in the teaser period where rates are still fixed) where the rate is lower than the current floating rate of 8.50% - 9% than wait till you are on a floating rate basis for shifting to the new regime. If you are paying interest rate in double digits then shift to the new regime immediately. If your existing lender is not giving you good terms for the shift or is not acting fast enough to shift you to the new regime then you should seriously consider shifting to a new lender altogether)

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The National Housing Bank (NHB) which regulates the housing finance companies – HDFC, LIC Housing Finance, etc.- will also be forced to come out with a similar system for HFCs which will be good for the home loan consumers. Similarly the scheme will have to be extended to NBFCs also by RBI though that is likely to have a smaller impact on the loan consumers.

In any case the impact of this fundamental change will be felt only over a period of time – at least 6-12 months as interest rates change (likely to increase) during that period. Here’s hoping that this change has a fundamental impact on all loan consumers.

Loans, probably being my ‘middle’ name, this question coming from me may surprise many as I have been advising consumers on various facets of loans for many years on a day-to-day basis. Here I would like to draw a parallel from Bollywood movie Dayawan where film ends with a question by child character - Was Dayawan (the protagonist who plays a mafia don with a heart of gold) a good person or a bad person?

Same way the consumer in modern day society is perplexed - Are loans good or bad?

Through this article I am attempting to make an analysis of this dilemma.

Ideally loans that create a productive asset or enhance earning capacity can be classified as good. Also loan taken to meet unexpected emergencies do not need a classification. They are a “must” rather than being good or bad. Thus the purpose of the loan plays a crucial role in deciding whether a loan is “good” or “bad”. The other deciding factor is the cost of the loan. The purpose of loan must also be cost effective. If you are undertaking “hair cutting” course for Rs. 20 Lacs, it may not be worthwhile, as the earning capacity may not be enhanced that much. Even when the loan is for a good purpose say paying the fee for an educational course that will substantially add to the earning capacity but if the cost of the loan is too high, then it will not remain a good loan.

So the purpose of the loan (and its cost) and the interest rate of the loan defines the hierarchy of “good” loans or “bad” loans.

At the top of the hierarchy most loans taken to fund education for self or a family member would normally qualify to be a “good” loan as they create substantial earning capacity relative to their cost and are normally available at a reasonable interest cost. Tax breaks on the interest would also reduce the post tax of the loan substantially.

Second would be loan taken to fund a reasonable cost house for your own residence. Normally this asset price appreciates in value and will also act as a source of pension income or retirement through the medium of a reverse mortgage.

Third would be a loan taken to buy your own reasonably priced vehicle (two-wheeler or four-wheeler). This may result in a boost in your productivity given that public transport in most cities in India is quite poor.

Then there are loans taken for consumption such as for funding or an expensive/ luxury consumer durable.

The consumerism boom fuelled by the presence of modern places of worship - Malls, has led to the phenomenal growth of plastic money. Swipe…swipe…swipe is the new mantra chanted by one and all. And the prasad of this mantra is debt…debt…and more debt. The debt on the credit card for longer duration will land you in a financial mess. The borrowing on credit card should not exceed 30 - 45 days, as interest charged is very high on such credit.

Last would be loan taken for speculative purpose such as investments in stock markets. These are strict No-No.

I would like to quote Benjamin Franklin here: “Remember, credit is real money,” which we tend to forget.

Even when you take loans, remember there are two types of loans - secured and unsecured. As the name implies secured has some collateral to secure the credit whereas unsecured doesn’t, so obviously it comes at a higher price. So when taking a loan is an absolute must then try for secured loan rather than unsecured loan.

So to end - remember loans can be very useful - nay - essential to improve the quality of your life and your future generations. At the same time it has the potential to destroy your life if used unwisely. The choice is in yours.

I hope you have got your answer!

Budgeting for a car is as important as budgeting for any other activity. Here are some pointers that will come handy when you decide to buy a car, old or new.

The first step is to work out your expenses; and then the savings. Check how much you can save up for your car. When you buy a car, there are many costs that come along with it. Keep a margin in your calculations to meet costs such as fuel bills, insurance premiums, and servicing.

Set a budget and stick to it. Ignore all that the dealers or the finance company has to say. Especially, if they say that you can afford more. And, there is NOTHING such as a ‘zero per cent’ loan.

Assess whether you need a brand-new car or if an old machine will do as fine. Depreciation is a major chunk of the cost of owning a car. Even if your car is just a year old, there is a hefty amount to be lost should you sell it. This essentially means that you can buy an old car on the cheap. If old is as good as new, why empty your pockets? Remember, buying a car as an investment option may not really work. Registration costs, insurance, maintenance; such costs can’t be recovered if you were to sell the vehicle.

While it is advisable to buy a house on loan, a loan should be the last resort to buy a car. Save up on cash to buy the car. Car financing can be expensive. And, no tax benefit on the loan unless you lease it out. Buying a car outright can get you discounts.

If you are looking for a loan to finance your car purchase; shop for a loan first. While a housing loan lays emphasis on the actual property, buying a car via a loan lays primary emphasis on the finance options available. Arrange for the down payment. DO NOT go the personal loan or loan against security route to get the cash.

Once you have checked out your finance options, assess your car. New or old, ascertain the one you need. Assess the purpose - whether you want to rent it or use it for personal needs.

An important step of budgeting is to get an estimate of the price. Do your homework and set a target price. Use all the channels available. The Internet being the quickest, visit as many dealers and agents as possible to get estimates.

Make negotiations before you purchase. Don’t let the dealer eat up your savings. Don’t take discounts as they are. Make sure the offers are indeed discounts, not future expenses hidden away inside them.

I am looking for investment and own home in Pune. I would like to know my best loan option. Should I go for a personal loan of AED 2 lakh with a 6-year tenure or a home loan in India with 10-20 years tenure? What are the taxes levied on NRIs and what will be applicable for me while purchasing property in India? I am planning to stay in Dubai not more than 5-6 years. I am married and my wife is a housewife. We have a 6-month old daughter. Education and cost of living in Dubai is very high and will be inflationary for the next 5-6 years. I am staying with my family in Dubai in rented premises.

In the current scenario when inflation is at its peak the middle class is going to be in the soup. They need to be aware of many ways in which they have to maintain their basic standard of living, for which people fall into the trap of debt. The most common and easily available loan to for a cash infusion with the lowest documentation is the personal loan. All loans if not taken for a purpose that is not of need it causes pain and could lead to distress.

Let’s see how an individual lands up in a debt trap:

Mr. X belongs to a middle class family with four dependants. His father is retired person. His mom and wife are not earning members of the family. Mr. X is the only bread earner for the family. He has a daughter who just started with schooling. Due to unavoidable personal responsibilities he had to take a loan of Rs.1,00,000 at 21% for one year. The EMI was Rs.9311.37. He was working with a private limited company where the pay is just so-so. His take-home pay is hand to mouth. After taking the loan, within the next three months he lost his job. He was unable to pay the EMI on time. He defaulted on his payments with the bank. After few months he got a job in a good MNC company and wanted to take on one more personal loan to repay the previous loan and come out of the defaulters list.

Since Mr. X already defaulted once, it would be difficult to fetch him a personal loan. To pay back the first debt he wants to go for a second personal loan. This would make him fall again in the debt trap. This time it would be difficult for him to come out of it.

Before taking a personal loan think that whether you genuinely require it or not. In case you have decided to go ahead for a personal loan do not just go with one bank and stick with their terms. A bank knows that a personal loan is more of an “individual’s requirement”. It is not a product which the bank needs to sell or offer it to the people. In current situations many of us are forced to perform things which we do not like, but still we have certain responsibilities to fulfill. This compel us take a personal loan to meet our current obligations or desires only. One does not even consider how much essential one’s credit-worthiness is. In future when one actually requires a personal loan it will not be easy. The bad track record would be an obstacle. It is better to find out with more banks and financial institutions with what rates they offer. Then take a call and find a best deal.

The other option is to take a secured personal loan. They have lower interest rates. The securities which lie in the lockers are of no use to us. In India we are very emotionally attached towards our possessions and we feel we can not deploy them for taking a loan. But if in case it fetches a lower rate of interest on your personal loan, then those possessions are invaluable. In India by personal we understand it is unsecured in nature. Our insurance policy, shares, investments made in National Savings Certificate, Kisan Vikas Patra etc can help you get a personal loan at a lower interest rate which other wise would be very high.

A personal loan is easy to obtain because the interest rate charged are very high. In financial markets there is nothing said as free lunch, you pay for each and every thing you want. So it is sensible to approach many banks and then go ahead with that bank which can offer you the best deal. Loan against security would be a better option. It will not give you sleepless nights.

Need to fulfill your short term cash needs? Personal loan is the solution. Personal loans are unsecured all purpose loans which can be taken by individuals to meet their short term cash needs. The quantum of personal loan is dependent on your income and repayment capacity. Personal loans usually have a high fixed interest rate with a fixed repayment period, you should always think of taking a personal loan as the last resort after you have utilized all other sources of cash.

Personal loans are available from Rs. 10,000 to Rs. 10 lakhs for any purpose depending on your requirement, you can utilize the money in any way you want to; there is no restriction on the end usage of the loan. Personal loans are given without any security, guarantor or collateral, resulting in a very simple, fast and quick approval process. The loan lifespan ranges from 1 year to 7 years.

The quantum and the interest rate of the personal loans depend on different factors:

1. Whether you are salaried or self employed
2. Your monthly income
3. Your employment stability
4. Total EMI payments towards your existing loans
5. Repayment track record of previous loans, if any
6. Your age
7. Your stability with the place of residence

The personal loan quantum and the rate of interest are totally dependent on your profile and the documents you provide for verification. After signing the loan documents, a demand draft or a cheque is drawn in your favour by the lender and you need to deposit post-dated cheques for the lifespan of the loan agreed by you.

Apart from the interest charged some other charges might be applicable. These charges can be charged at the time of disbursement of loan, during the lifespan of the loan, or when you terminate the loan. These charges include (a) processing charge (b) pre-payment fee (c) late payment charge (d) cheque bounce penalty (e) documentation charges (f) duplicate statement fees

Who can take a personal loan? Personal loans are provided only to resident individuals in India. Banks do check on your age minimum being 25 years and maximum being 65 years, your salary or income (if self employed), stability of profession and place of residence.

Before you proceed for a personal loan do ask few questions to yourself:

1. Is personal loan the right option? As stated above, personal loans are very expensive and you should only opt for this when there is no choice left with you and you are in need for short-term cash.
2. Is my loan lifespan appropriate? Do analyze your daily expenses, otherwise to repay early you might have to cut down your even your necessary expenses. The early repayment might not be the better option in that case.
3. Am I taking advantage of all the discounts I’m eligible for? Women get discount in many public sector banks, NBFC/Banks provide discounts to existing customers, do check on this and avail the discounts available and you are eligible to.
4. Have I chosen the right repayment schedule? There are options available for repayment of the loan, it can be larger payments at the beginning (upfront) or larger payments later in the lifespan of the loan.

You must choose a personal loan repayment period and schedule that matches your needs. Choose a shorter repayment period if you are expecting an inflow of cash in short run, this will help to meet your immediate cash needs and you will be able to repay the loan with less amount of interest.

Most banks and NBFC provide group life insurance as loan protector insurance. Purchasing this insurance ensures that the insurance company pays the lender in case you meet with an unfortunate incident. This protects your dependents from your liabilities.

A comparison of short term credit options:

Using the above table you can choose an option of a short term loan, with a view of repaying it as early as possible.

I took a personal loan from a finance company called Prime Financial. The loan was of Rs. 27, 000 for 30 months with an EMI of Rs. 1, 477. What is the actual rate pf interest? They did not give me any documents stating loan related information. When I ask them whether the loan can be closed, they tell me about some charge called the prepayment penalty which is around Rs. 23, 000. I have already paid 14 installments. Can the bank do something like this?

I had applied for a car loan in the month of October (2007) from HDFC Bank and it was approved. But, at that time, the HDFC Bank executive told me that my name shows in the defaulter’s list as Richa. One of my cousins has the same name.

When I applied for a personal loan from Barclays Bank, they rejected it, stating the same reason. I am sure my cousin never took the loan or ever used any kind of proof from my end of such a thing. What do I do?

HDFC Bank is charging me service tax on interest paid for a personal loan (availed against a credit card) EMIs being paid every month. The loan interest is not a kind of service. Is the bank correct in its policy of charging me the service tax for the same? I did speak to the bank officials and they said that, “We take this opportunity to clarify that as per current Government of India guidelines, service tax as applicable will be levied on the prescribed fees, interest and other charges as applicable from time to time. Service tax will be applied on each of the applicable items and will be reflected in the Card member’s statement. We would like to inform you that the service tax has been recently revised from 12.24% to 12.36% effective from 11th May 2007. Hence, all EMIs that are being billed currently carry the difference in the service tax as ‘ADD CESS’ and the same is payable by you.” Is it correct on bank’s part? Please advise.

I have a very bad credit records for various reasons. Currently, I have loans amounting to Rs. 15, 00, 000, in spite of the fact that my wife and I earn pretty well.

These debts have accumulated as a result of excessive expenditure towards education of my children and other contingencies. I also have a history of cheque bounces on my account. My weak financial situation will last for another two years, till the completion of the education of my 2 children who are undergoing their 5th semester (of an eight-semester course) in Engineering. Once my children are through with their course, I may be able to save some money, even if we don’t get any financial support from them. I am also willing to ensure full security of bank loan in case of my death or retirement as a normal course. I am a salaried individual with 7 years of service pending before retirement. Will there be a bank willing to lend me? The situation I am in was unavoidable; will this mean that I can’t get a loan ever? Can I get some sort of a loan with an option to pay of the loan within 10-20 years. I can afford to pay an EMI of Rs. 17, 000 per month.