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Personal loan rates: Not always cheap, banks may charge high interest

Banks readily dole out personal loans these days. You may be able to get them fairly quickly too. However, remember that what comes quick may not be necessarily cheap.

Harsh Roongta

11 Jul 2007

It was just another day at work when I got a call from the direct sales agency (DSA) of a reputed bank, inquiring whether I am interested in a personal loan. Before I could consider the merits of the bank and the loan in question, there came another offer from the same DSA: 'Sir, we can arrange one for you from any other bank as well!

Welcome to the world of retail banking, where both Indian and multinational lenders are fighting to increase their market share. And it's not restricted to the personal loan arena - the battlefield extends to home loans, credit cards and auto loans.

When it comes to personal loans, if you are willing to take it, they are always willing to give it! Offered with minimum hassle and without any security, they often lure many customers to personal loans which they may not even need. However, it is always advisable to be a little careful and read the fine print of such 'easily-available loans'.

Let's take a look at a personal loan product better known as 'Janata loan' or small-ticket loan or low-emi loan. While the nomenclature could be different, the loan products are basically same. And while they could be easily available, they could also cost you much more than any other product in the market.

These loans are specifically meant for low-income groups which include stenographers/clerks/typists/peons/drivers/administration assistants/ cleaners/watchmen etc. who otherwise find it very difficult to get bankers interested in them. These loans are typically designed to suit their needs.

Here are the workings of these small loans which explain the cost benefit of such products.
A typical product would have the following tenets:

1) Loan amount: Rs 10,000 Rs. 75,000

2) Minimum salary: Rs 4000 (net)

3) Documentation:

  • Three months' salary slips & bank statement to assess repayment capability, existing commitments or loans etc.
  • Identification proof & residence proof
  • Letter of employment & salary drawn from employer if salary slip is not available
  • Processing fees from 3 per cent to 4 per cent of the loan amount.


4) Tenure: 12 months to 30 months, and

5) Interest rate, the most interesting part of such loans

The table below gives a good idea of how much this loan is actually going to cost you (All figures are hypothetical).

Case Scenario

Loan Amt. (Rs.)

Net Monthly Sal. (Rs.)

No. of Dependents

Tenor (In months)

EMI (Rs.) (Approx.)

Interest Rate (Flat)

Interest Rate

1

25,000/-

4,000/-

2

24

1,465/-

20.32%

35%

2

50,000/-

9,500/-

2

30

2,559/-

21.42%

36%

3

60,000/-

10,500/-

3

24

3,649/-

22.98%

39%

4

20,000/-

5,500/-

5

24

1,224/-

23.44%

40%

5

75,000/-

11,000/-

4

30

4,022/-

24.35%

41%


The table shows the interest rates charged by the banks for such loans. The range can be clearly identified as anywhere between 20 per cent to 25 per cent for FLAT interest rates. In other words, the reducing balance rates would be much higher. As per our example, it would be anywhere between 35 and 40 per cent.

Add the complex structure of Equated Monthly Installments (EMIs), the hidden cost of processing fees which are deducted in advance & the rates go up by another 2 per cent (for FLAT rates) or a good 4 per cent (for reducing balance rates)

Why are these interest rates so high? Bankers argue that personal loan being a totally unsecured product, there are chances that borrower might default. In other words, the bank takes into account the high risk element in these loans. Moreover, 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.

However, many consumers are attracted to such loans, simply because of the fact that personal loans are available easily in India. However, if you need a personal loan for an emergency, you must keep in mind that these loans are rather expensive. In simple words, remember that something that is easily available is never cheap.

*{Reducing balance is a calculation methodology of interest only on the outstanding amount at the end of a particular period e.g. monthly/ quarterly/ half- yearly/ yearly rests since EMI comprises of principal component as well as interest component}