Today you can get a personal loan for almost anything: funding for an upcoming trip, shopping for a mobile phone, or even paying off your existing debt.
While the names may vary, all of these are essentially bucketed under the category of ‘consumption loans’ popularly known as ‘personal loans’.
Nearly 32% of us Indians struggle to pay even INR 50,000 unprecedented expenses, no wonder ‘personal loans’ category has been growing by 21% year-on-year since 2012. And not surprisingly default percentage in these small-ticket loans is also less than 0.5% (4.5 in every 1000 people default in repayment)
Given the low ‘ticket-size’ and low default probability, Industry has been flooded with new-age fintech companies (apart from Banks/NBFCs) to get a piece of the growing ‘personal loan’ industry.
Most of the companies are promising to sanction you instant personal loans with zero documentation. Most of these companies have been pushing very hard to give you money for your non-urgent ‘wants’.
It seems apparent that these companies (along with Banks/NBFCs) are trying to gain something out of our insecurity.
If you’re among the 32% Indians who are finding it hard to meet your unexpected expenses and you’re thinking of availing an ‘instant personal loan’, this post is for you!
Through this post, we’re going to have a look at below points to make us a little more aware of what we’re getting into:
- What’s in it for the Banks/Fintechs
- Common pitfalls for customers
Let’s move ahead..
What’s in it for the Banks/Fintech Companies?
Let’s be honest – Personal Loans are unsecured, almost documentation free, available at the click of a button & hassle-free – all the things we wish our lenders to be.
But the mind wanders!
Do Fintechs/Banks stand to gain anything from being so agile or are they doing this to genuinely help people and increase India’s credit off-take?
No points for guessing.
Companies make a killing by giving you money. It is the safest and one of the quickest ways for the companies to multiply their capital.
Charging absurdly high interest rates (18-20%) is just one of the ways to make money – borrowing cost for most of these NBFCs/Fintechs is less than 10%, better the credit rating of NBFC lower the cost of borrowing
Effectively with the interest you pay to these companies, they’re able to recover the cost of 2-3 borrowers (including yourself). Never thought of that, right?😵
Thankfully, these interest rates are informed to the borrowers beforehand.
There are a few other charges which are not told clearly and borrowers are left no choice but to pay these charges.
So, what are these?
1- Processing Fee/Origination Fee
Customers are told that this is the fee we have to pay for getting documentation, evaluations, work and record of loan repayment.
Hidden under all these jargons, we forget that a Bank’s full time job is to do all of those things. We shouldn’t have to incentivise them to be doing these, especially when they are already charging a bomb (hefty interest rates)
The fee is divided among DSAs (Direct Selling Agent: person who calls you repeatedly for taking that loan) and Lenders, so effectively you (unknowingly) are paying to all the participants in the process in addition to the exorbitant interest rates.
Usually companies stipulate a 2.00-4.00% Proc. fee which could run into lakhs, and for loans of relatively smaller amounts a floor (minimum amount to be paid) is stipulated.
Another important thing to be noted is, these are usually negotiable since a large part of this fee is commission. We’ve seen multiple cases of getting these reduced to few thousands
2- Prepayment Penalty
Once the borrower gets their money for an agreed period of time (say 2-3 years). You won’t be able to pay money before agreed time even if you have liquidity.
But shouldn’t companies be happy if they get their money back sooner than they expected?
Why is that?
Because Companies/ Banks/ NBFCs do not want to let go off their hefty interest incomes
Even if you wish to prepay all the money, they would charge you a penalty of 4-5% on the amount not yet paid. This way they try to make some ‘extra’ income from the borrower before ending the relationship
Penalty for late payments: Delay in paying the EMI hurts in you in more than one way:
- It badly affects your CIBIL score
- Penalty of up to 26% p.a.
You heard it right, 26% per annum!😮
Though there isn’t much companies can do to cause a delay, but as per latest research ~ 11% of the borrowers default on at least 2 EMI payments
Every EMI delay attracts 2% penalty, that’s extra 4% for these companies
There are host of other charges which customers are typically unaware of, some of these are
- Loan cancellation charges (INR 2000-10,000)
- EMI Bounce charges (INR 250-1000 per bounce)
- Repayment Mode Swap Charges (INR 500-1000)
Let’s look at a simple statistic
Let us compute the amount you would have to pay back if you’ve availed a Personal Loan of INR 1 lakh for 4 years and assuming you’ve to pay the entire amount after 4 years (interest rate is taken as 18%).
Answer may surprise you.
You would have to pay back a total of INR 2,03,360 including all the fees.
2X the amount you borrowed!
If the prepayment is in the form of EMI, you would still have to pay a total of INR 1,60,174
You still end up paying almost 1.6X the amount you borrowed even if you pay back monthly payments.
Now that we know why Banks are so motivated to give you their money, let’s look at why customers avail such high-interest loans
Common Pitfalls for customers
1- Shop now, pay later
We all would have to agree that the biggest marketing campaign of previous decade has been the phrase ‘shop now, pay later’
Most of us fallen into the trap of this marketing campaign, they even make you believe that there are ‘ZERO’ charges to availing this
Which is, obviously, not true.
So why do we fall for this every time?
Answer is deeply rooted in our desire for Instant Gratification. Why save the money for a year when you can immediately buy the product now and pay in EMIs?
Even if we have money to pay for that product, we opt for such schemes.
If we know the charges associated with these ‘ZERO’ charges scheme, we would definitely have second thoughts before availing these.
Retailers typically embed the cost of interest (16-24%) in the actual price of the product and sell the products at higher price. Voila!
So, a consumer who otherwise could have availed a loan @ 12% ends up paying 18-20% under the pretext of no-cost EMI
2- Easy, Hassle Free, Quick
Most of the Companies/Banks wanting to give you money would want to do their due-diligence (which takes time), the companies which are promising you to give you money at single click will charge you much higher
But, why is that?
High risk = High reward
Think in terms of you lending your money to someone else, you would want to be doubly sure and would want to carry out entire due diligence before lending.
It is no different for these companies.
All the new age Fintech companies are trying to woo customers by introducing terms like Easy. Hassle Free but then there’s a cost associated with every one of these terms
Another important point to note is, the borrowing cost of all Fintech players is much higher than established NBFCs and Banks. These additional costs are then recovered from the borrower
Availing a personal loan is easy but the key is in understanding what you’re getting into.
There are a lot of fine prints in T&Cs that go unread, exorbitant charges and other fees customers should be aware about.
In our next post we shall be looking at some of the T&Cs which you agree to and sign those Bank agreements while availing these Loans.
We have been helping our customers to avail the best deal available in the market with the most favorable T&Cs. In case you’d like our assistance you can contact us
Until then we hope you give some thought and spend a little more time before getting into the trap of ‘Instant loan’