Borrowing money in the form of a loan can be a powerful financial tool to improve your quality of life. For example, loans can help you get a university education, own a home or purchase a new vehicle. However, loans can be financially crippling if used incorrectly. Use this guide to navigate your loan search process and find the optimal loan for your financing needs.
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What Type of Loan Do You Need?
As a general rule of thumb, you should consider specific-use loans (e.g. home loans, education loans) before you consider more general loans (e.g. personal loans. This is because specific use loans tend to charge lower interest rates than personal loans. This is logical if you consider the banks perspective. As a lender, it is less risky to loan money to someone who has a clear purpose for the funds, such as attending university or purchasing a home.
If your financing needs fall outside one of these categories, you still have options. For instance, if you desperately need cash for a large, unexpected expense, personal loans can be a great financing tool for costs related to medical procedures, weddings, or moving. In general, we do not recommend personal loan use for unnecessary, short-term expenses, but this type of loan can be of great use to those that desperately need the cash.
Regardless of the type of loan you require, it is important to shop around and compare the best offerings available from each lender. Here at ValueChampion, we are dedicated to combing all of the available loans in India in order to make this process easier for you. To compare the best home loans or best personal loans, visit our respective pages.
How to Compare Loan Offerings
It is important to be well versed in the basics of loans before you decide to apply for financing. For example, many banks advertise interest rates "as low as" or ranging from X% to Y%. When possible, we decipher tricky language and loan terms to make sense of these issues. However, in some circumstances, you should also contact the lenders directly to see what rates you are offered.
Additionally, it is important to be able to compare various loan types, in terms of affordability, before deciding on the best product for your needs. As we've mentioned above, some loan types tend to offer lower interest rates than others. Fortunately, for prospective borrowers in India, most lenders tend to advertise "rest rates", making it easy to compare rates across loan types and lenders. The best way to think about rest rates is that they charge you monthly based the amount of money you have not repaid to the lender.
For example, a 3-year, Rs. 50,000 personal loan with a 12% interest rate will require monthly payments of Rs. 1,661 each month. However, in the beginning months of the loan your payments will consist primarily of interest, as the interest rate will be charged against the remaining balance, which still remains relatively high. For an illustration of how a rest rate is charged on this example loan, please refer to the table below.
|Year||Monthly Payment||Annual Interest||Annual Principal||Ending Balance|
|1||Rs. 1,660.75||Rs. 5,208||Rs. 14,721||Rs. 35,279|
|2||Rs. 1,660.75||Rs. 3,341||Rs. 16,588||Rs. 18,691|
|3||Rs. 1,660.75||Rs. 1,237||Rs. 18,691||Rs. 0|
|Total||Rs. 59,787||Rs. 9,786||Rs. 50,000|
In other countries, it is common for banks to also charge "flat rates". In case you ever come across this type of rate, it is important to understand that it is different because it charged a set interest rate against the total loan amount. For example, a Rs. 50,000 loan with a 12% flat rate would charge the same amount of interest every month and Rs. 18,000 in total interest over the course of the loan. This is clearly much more expensive than the effective rate example above, and illustrates the importance of comparing loans by total interest cost divided by loan principal, which is also known as the effective interest rate.
Optimise Your Loan Amount, Tenure and Total Cost
Once you've narrowed down your preferred loan type, it is crucial to apply for the right loan size and length. The tricky balance is to find a loan that allows you to adequately finance your purchase, while allowing you to comfortably make monthly payments, all for a total price that you find reasonable.
To break this idea down further, it is important to decide exactly how much financing you will need. In some cases, banks will loan you as much as 90% of a home's value, provided that you are able to make a downpayment for the remaining 10% of the home's value. However, we strongly suggest that you make a more significant downpayment in order to limit your overall indebtedness, as this can limit your ability to sustain a reasonable budget or to apply for future loans. Those that already have a significant amount of personal debt should be particularly aware of their current debt obligations when applying for a new loan.
With this in mind, you must also consider that large loans require large monthly payments which can eat into your current budget. For this reason, it can be helpful to choose a longer loan term and stretch the total interest cost over a few months. That said, a longer loan term means that you will end up paying more in total, as you will be charged interest on your debt over a longer duration.
There is no one-size-fits all way to find a balance between these factors. We recommend that prospective borrowers carefully examine loan offerings in order to find a loan amount and tenure that allows them to finance their purchase while being certain that they will be able to make their required payments each month and fully repay their debt by the end of the loan's tenure.