Harsh Rungta / DNA

Mumbai, Jul 19: Sales agents of banks can be very pushy when it comes to selling personal loans. Just the other day I got a call from a direct sales agency of a reputed bank asking me if was interested in a personal loan.

The interest rates offered were not attractive enough. And while I was still thinking about it, pat came another offer: "Sir, if you are interested, we can arrange for a personal loan from any other bank as well."

Welcome to the big bad world of retail banking in India - where a war is on for market share. And this war is happening across the various loan businesses, not merely personal loans.

‘No questions asked, no reasons required - we are ready to give it, if you are ready to take it’ - seems to be the general line.

Given the high decibel selling, a customer needn’t either disclose the purpose, or furnish any security/ guarantee - indeed, chances are one would be lured into taking a personal loan he may not even require.

Which is why, one should be very careful before biting the bait.

To understand the nitty-gritty of personal loans, let’s take a look at a category of personal loans, generally referred to as ‘janta loan’ or ‘small ticket loan’ or ‘low EMI loan’.

The names may be different, but the products are largely the same. And while they may be as easily available as over the counter products, you may end up paying much more than any other product in the market.

Ironically, such loans are meant for low income group individuals who the banks generally like to avoid. Let’s take a quick look at what the salesman offered me.

Loan amount: Between Rs 10,000 and Rs 75,000

Income eligibility: Minimum net salary of Rs 4,000 per month.

Documentation: Three months’ salary slip and bank statement to assess repayment capability, existing commitments or loans, etc.

Identification & residence proof: Letter of employment & salary drawn from employer if salary slip is not made available.

Processing fees: Ranging from 3 per cent to 4 per cent of the loan amount.

Tenure: Between 12 and 30 months

Interest rate: This is the most interesting part. What you end up paying is clearly way more than what they promise to charge you.

In such cases, banks would like you to believe that they are charging an interest of 20-25 per cent. But, that is not the case, since the actual rates can be as high as 35-40 per cent.

What banks promise while convincing you to take the loan is “flat rate of interest.” Let’s see how this is computed. Let’s say you take a loan of Rs 50,000 and repay it over a period of 30 months through an EMI of Rs 2,559.

Hence, the total amount you repay over a period of 30 months comes to Rs 76,770. You have taken a loan of Rs 50,000. The amount you have paid over and above that, i.e. Rs 26,770, is the interest you pay.

Since the loan is for a period of 30 months, i.e., 2.5 years, the interest paid in a single year is Rs 10,708 (Rs 26,770/2.5). An interest of Rs 10,708 on a loan amount of Rs 50,000 means an interest of 21.42 per cent in a year.

But this logic given to you by the bank is not correct. What the banks don’t tell you is that every time you pay an equated monthly installment (EMI), a certain amount of the original loan is also repaid.

Hence, interest should actually be calculated on the loan outstanding at any point of time and not the original loan you had taken.

In the illustration, what was conveniently left out was the principal being repaid every year. Interest should always be calculated only on the principal outstanding at the end of each month, and not on the original loan amount.

When interest is so computed based on the diminishing principal amount outstanding, called the ‘reducing balance’ method, the rate of the actual payback works out to be much higher.

In the illustration, the actual rate of interest works out to 36 per cent and not 21.42 per cent as the salesman would have me believe. Add to this the hidden cost of processing fees, which are deducted in advance, and the rates increase further by 2 per cent (for flat rates) and a good 4 per cent (for reducing balance rates)

So, why are these interest rates so high? Bankers would argue that since these are totally unsecured products, there are chances that some borrowers would default.

In other words, those who are likely to pay up are being charged more to cover the defaults by others. Also, given that the loan amounts are rather small, the cost of processing such loans is much higher.

However, the overall cost just does not justify the risk profile, or for that matter, the processing cost.

Yet, many consumers are attracted to such loans, simply because they are available easily. For those who need money urgently, especially, these can be a godsend.

All the same, one must keep in mind that what is easily available is never cheap.