At a time when corporate loan growth has slowed down, retail loans have reached a new high, at 25% of overall loans in February, as per RBI data. The bulk of the growth in volumes is happening in small-ticket loans like credit cards or unsecured loans. A report by Kotak Institutional Equities says that retail loans are likely to grow at 16% CAGR over FY2018-22 and their contribution to overall loans to increase to 28% from 18% in FY14. It expects most private banks and State Bank of India to gain share in this leg of the cycle. The granular data on loans show improving share of private banks as compared to public banks and unsecured loans like credit cards and personal loans as compared to secured loans like home. The report underlines that banks have altered their strategy to grow their share of retail loans for two main reasons. One, the corporate loan-book slowdown is still not complete while recovery is likely to be anaemic, and two, retail loans went through a cyclical slowdown post FY07. “Over the past few years, retail consumer balance sheets have been far stronger than corporate balance sheets, which resulted in negligible impairments over the past few years. This has instilled confidence in banks to shift focus to retail,” it says. While banks are on an overdrive to lend to you, here are three rules of borrowing that potential customers must keep in mind to avoid any fundamental mistake.
Borrow as much as you can repay
Always make sure that your loan-to-income ratio is within acceptable limits. Spending too much on EMI can derail your important financial goals. Typically, your housing loan EMI should be less than 40% of your income, car loan less than 15% and personal loan not over 10%. Also, keep in mind that the overall EMI payout of all loans put together should not exceed 50% of your monthly income. Never miss or delay an EMI as it will impact your credit profile and hinder your chances of taking a loan for other needs later in life.
Shorter the tenure, less the interest paid
If you keep the tenure of the loan short, your interest payout will be less. Typically, for a home loan, the tenure is for 25 years. Do not stretch it to 25 years. For a car loan, it should not be more than five years. Younger borrowers tend to go for a longer tenure, to ease out the EMI burden initially. It is wise to partly prepay the outstanding principal whenever you have some spare money which will reduce the tenure and subsequently the interest payout in the long run.
Substitute costly loans by pledging investments
If one has too many unsecured loans, then it makes sense to repay them by taking loan against pledging investments like mutual funds and life insurance to banks. The interest rates on loans against these products are much lower than for personal loans. Banks offer loans on the value of units held in the folio of an investor’s mutual fund account after seeking a lien on the units in the name of the bank. Once the loan is repaid, the bank will lift the lien and the investor gets the rightful ownership of his mutual fund units. For equity-based mutual funds, one can get as much as 50% of Net Asset Value (NAV) as loan amount. In life insurance, banks give loan against traditional life insurance, including endowment and money back features and even linked policies. However, banks do not give loan against term plans. The loan has to be repaid during the term of the policy.