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• One should evaluate his/her ability to take care of any existing financial obligations before deciding on availing a loan
• It is advisable to take your family’s & friends’ counsel before deciding on taking a loan or making a long term financial obligation
• One must take adequate life insurance in the event of availing a large loan. This is important to avoid any liabilities to the family members in event of death
  

• Provides capital to help you make an investment in business or property
• Finances the purchase of an automobile (can be a utility product for a self employed person or to improve one’s living standard) or other appliances
• Provides immediate cash for expenses such as discretionary purchases, taking a vacation, meeting urgent medical needs, paying for school/college tuition & fees, etc
• Loans used to consolidate one’s debt owed to a host of lenders
  

The primary factor one should consider before availing any of the aforementioned loans should be one’s ability to pay the EMI (Equated Monthly Installment) through his/her current or projected income during the loan tenure.

The pitfalls of not repaying a loan includes -
• Impairment of one’s credit history with the credit bureau which can impact one’s ability to avail a loan in the future.
• Criminal/legal proceedings against the defaulter.
• Standing in the society could be adversely affected.
  

Loans are taken when our own resources are not enough to meet our need of purchasing an asset, making an investment or to finance expenditure.

Factors that influence your decision to take loans include -
• Loans that create a productive asset or enhance earning capacity.


• Loan taken to meet unexpected emergencies.


• Cost of the loan -
  • The purpose of loan should be cost-effective. If you are undertaking a loan for which the earning capacity is not enhanced compared to the cost of the loan, then your current income should be sufficient to service the loan.
  • If the loan is for a good purpose (e.g. Paying tuition & fees for an educational course), you still need to analyze the cost of the loan & benefit derived to justify the loan. You should always ensure that you have the ability to repay the loan with your current income.

• A loan can be beneficial based on the kind of loan & if the benefit derived can outweigh the cost
• An education loan for yourself or a family member might qualify as a good loan if the benefit derived from it outweighs the cost of the loan.
• Loans taken for home or property, might also qualify as a good loan if the asset price will appreciate in value. This is also required to meet the basic need of housing. The asset can be used in times of emergency to raise resources by pledging the property or by using Reverse Mortgage option post retirement to monetize the property.
• Loans taken to buy a vehicle, which helps in improving your standard of living and/or be used as a utility product by a self employed individual.
• Loans taken to enhance business or invest in growing business.
• Loans taken for purchasing consumer durables (e.g. Television, Washing machine, Refrigerator, Air conditioner, etc) to improve standard of living provided one has the means to repay them and it also depend on the source of finance used to finance these. If one plans to buy these with a credit card, the borrowing on a credit card should not exceed the due date (generally 30-45 days), as the interest rate charged is very high. Hence, a more preferable option is to avail a loan to purchase such products.
  

Taking a loan is useful, if it provides capital that allows you to make a pending purchase and if you are confident and comfortable that you have the capacity to pay your EMI on time.

A loan should not be taken if you don't have the required income level to pay back the liabilities owed to the lender in a timely manner.

Loans for consumption:
A personal loan taken to spend the money towards discretionary expenses, taking a vacation or daily expenses should be backed by your capacity & intention to repay the loan. The situation can turn precarious, if you have no means of paying the loan back because the consumer is left with only liability towards the lender. By taking such a loan, there is no asset that you are building. Taking a loan to fund a lifestyle that cannot be supported by your income is bad for your long-term financial health. In addition, it also impairs your credit history and hurts your chances to get another loan in the future.

Loans to purchase auto or appliances:
Auto loans and other product/ appliances depreciate quickly in value. However, auto loans help in enhancing one’s living standard and can also be used as a utility product. A prudent consumer should take these loans if he/she is confident that the loan can be repaid. Taking a loan for consumption is not bad as long as one knows that there are means to pay it back.

Important checklist before taking a loan
• Reputation of Financer: One must check the reputation of the financier or financial institution from where loan is being borrowed. Simple checks consist of standing of institution/NBFC in industry, the RBI registration as NBFC and promoters standing of the financial institution. The above should be checked before handing over fixed collateral to the financier. It is very important to safeguard one from unethical practices which can be adopted by small time fly by night operators without a RBI registration.


• Structure of loan product: The matrix below shows the Tenor & Cost associated with different kinds of loan. Based on your scenario, you should evaluate different loan options to select which is the best loan type for you



Loan	Type	Tenor	Cost
Personal Loan	Unsecured	Medium	High
Business Loan	Unsecured	Medium	Medium
Credit Card	Unsecured	Short	High
Working Capital Loan	Unsecured	Medium	Medium
Loan Against Property	Secured	Long	Low
Loan Against Security	Secured	Medium	Low
Home Loans	Secured	Long	Low
Auto Loans	Secured	Medium	Medium
Loan Against Gold	Secured	Short	High
Equipment Loan	Secured	Medium	Medium

• Evaluate whether the loan is for building an asset or to fund consumption.
• If you are taking a loan to buy an asset, ensure that if the asset is not generating income, then you have the means to pay the loan back in time from your current or other envisaged sources of income.
• Is the asset you are buying with the loan expected to appreciate or depreciate in value, i.e. (whether it will have significant realizable value).
• You should be able to afford the EMI payment of the loan, in addition to the existing EMI and other fixed commitments you might have.


• Evaluate your expected income and expected expenditure during the tenure of the loan before opting for a loan.
  • Evaluation of expected income is very important when selecting a loan product. E.g. ( if you envisage a lump sum payment in the near future, you can opt for a loan from a financier who allows easy prepayment terms).
  • If you assess your income to be erratic and without a definite pattern, the EMI being opted for should accordingly be chosen and tenure of the loan should be chosen to minimize the EMI. You may ask for inclusion of clause of part pre payment to reduce your interest burden in this case.
• Analyze all aspects of the loan such as term of the loan, EMI, interest rate, etc.
• Analyze if you want to opt for higher loan tenure as opposed to a shorter tenure. A longer duration will reduce your EMI amount but it also means higher interest payment.
• Evaluate the penalty you will incur, if you are unable to pay your EMI. Also analyze the rights the lender has and the actions he can take if you do not repay your loan.

The amount & stability of your income is required to determine your earning capacity. If you plan to take a loan based on future estimations of income & career growth, you need to understand & account for the EMI payments based on your estimation of future income which may result in EMI decreasing as a percentage of your total monthly income.

Some of the questions that you need to answer before making this decision are -
• How much increase do you expect on a yearly basis? How confident are you in getting this raise?
• Is there any risk of you losing your job/source such that you might not be able to afford to pay the EMI?
• What are your chances of getting a new job/source of income in case you lose your present one?
• Will large EMI payments interfere with your goals of retiring early, taking a mid career break, or even paying for your children's education and marriage?
• Will your spouse continue to work and financially contribute to the loan payment?
• Do you expect to get a lump sum bonus or variable pay at the end of the year that can be used to repay your loan( for this scenario, having a prepayment clause might be beneficial)
• A realistic view of what your income and career prospects can support is necessary while not being over optimistic about your future income. ( a worst case scenario should be that your current living standard is not impacted in the event your projected growth is not realized)
  

Short term (High interest) or long term (Low interest)

Loans can be taken for short duration as well as for long term, evaluate the needs and benefits before deciding on the tenure.

a) Short Term Loan:

Advantages of opting for short term loans are -
• Quicker processing & loan disbursal


• Less paperwork


• Easy qualifying with stable employment


• Liability restricted for a shorter duration.

Disadvantages -
• Higher interest rates than long term loans


• EMI amount would be higher for same quantum of loan (can be an issue if repayment capacity has not been properly assessed).

Short term loans offer quick solution to meet your urgent financial needs. If short term loans are used for funding an expensive lifestyle or for making expensive purchases without sufficient means to pay back, it might compound your financial problems. A short term loan is a good solution when you encounter an emergency and when you are certain that you can repay the debt. If you are in great need of a short term loan, make sure you budget for the repayment of the loan.

b) Long Term Loan:

Advantages of opting for Long Term Loans -
• Lower interest than a short term loan


• Higher amount can be borrowed to meet bigger needs


• Lower value of EMI in absolute terms

Disadvantages -
• Long term monthly payments ( liability is for a longer duration)


• Lengthy paperwork


• Delayed access to funds


• Many long term loans are variable interest rate products which can impact your eventual outgo.

Long term loans are a great way to fund big money requirements. You can use it for business expansion, home improvements, car purchase, etc. If you have a good credit history, your interest rate will be lower than your short term loan. Long term loan do however take more time to be finalized as compared to short term loans.

Long term loans and short term loans are used for different situations. Short term loan are usually availed when people require money quickly to meet a crucial financial problem. However short term loan also mean short tenure and higher cost.

The loan you take falls into two categories, secured and unsecured. Secured loan has some collateral to secure the credit whereas unsecured doesn't. Hence the cost of an unsecured loan is higher compared to secured loan.

A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral for the loan. If the borrower fails to repay the loan or defaults, the lender takes possession of the asset used as collateral and may sell it to regain the amount originally lent to the borrower.

There are numerous purposes for a secured loan -

1. Providing a secured loan, helps minimize the financial risk the lender bears as it allows the lender to take the asset in the event that the loan is not repaid.
2. For a secured loan, the loans are provided on a more favorable term as opposed to an unsecured loan. The lender may also offer a loan with attractive interest rates and a longer tenure
3. For a secured loan, the lender restricts the loan value to a percentage of the current asset value. This is a good option for a discerning borrower, since future increases in the asset value would enable him to leverage the asset .

• Specific Asset based loan (e.g. Auto loan, Commercial vehicle loan, 2 wheeler loan)

  Loan required to purchase a car, two wheeler or other commercial/ non commercial vehicles.

• Home loans

  Home loan is the sum of money a bank or financial institution lends you to help you buy a home.

  By taking a home loan from a lender, you pledge your home as the lender’s security for repayment of your loan. The bank or financial institution will hold the title or deed to the property till the loan has been paid back with the interest due for it.

  Home loans are generally taken for long tenures as the loan amount is usually a huge sum. The amount of loan one is eligible for is dependent on the individual’s credit profile.

• Product loans i.e. consumer durables

  A Consumer Durable loan is a loan for purchase of household items like Washing Machines, Refrigerators, AC's, Color TV's, LCD, Microwaves etc.
  Consumer Durable loans are short tenure loans. The amount of loan one is eligible for is dependent on the individual’s credit profile.

• Equipment loans

  Equipment financing is easier than other forms of financing as the asset to be acquired becomes collateral. This is more favorable to the borrower if the equipment is for a general purpose (as opposed to a specific purpose) with limited obsolescence.

  Equipment loans vary in terms of borrowing amounts. Equipment financing includes machinery, business vehicles, computers, electronic technology, tools or other fixed assets. The amount of the loan depends on the cost of the equipment/ fixed asset purchased or refinanced.

Secured

• Loan Against Property: Loan against Property is a loan which can be availed against an existing property. The property is used as collateral for availing the loan.

  Loan against property are generally taken for long tenures as the loan amount is usually a large sum. This enables a person to leverage his fixed assets to meet cash flow requirement. The amount of loan one is eligible for is dependent on the individual’s credit profile.

• Loan Against Shares/Security: A loan against security is a loan secured by financial assets. Borrower pledges the financial asset owned to the lender against the loan. The lender can take the financial asset in case borrower is unable to repay the loan as agreed. By using a collateral loan, the lender takes less risk, and it is easier for borrower to get funding.

Unsecured

• Personal Loan: An unsecured cash loan is called a Personal loan. This implies that one doesn’t have to give any security, as with a car loan or a home loan, where the underlying asset is mortgaged. The advantages include flexibility of use as one can use the amount the way one want however it is relatively at higher cost. The lender will look at a strong credit history before extending this kind of loan.

• Credit Card: A credit card is used by its holder to buy goods & services based on the holder’s promise to pay for these goods & services in the future. The credit card companies (issuer of credit card), grant the user a line of credit against which, the user can borrow money to make a payment.

• Working capital loan: Working capital loan helps provide cash to businesses to keep them growing and helps them cover their expenses out of revenue. These funds can be used to pay rent or mortgage payments, utilities, marketing expenses, inventory, employees, etc. Obtaining a working capital loan is difficult hence the borrower is required to have a good business credit profile.

An informed borrower can switch between various loan products to suit his current environment.

Credit history is a record of an individual or company's past borrowing and repaying. A credit history helps a lender to determine whether a potential borrower has a history of repaying debts in a timely manner.

The Credit Information Bureau India Ltd (CIBIL) is a repository of information which contains the credit history of all existing consumer & commercial borrowers. CIBIL provides this credit information to its members in the form of a credit information report. As in, an individual or commercial establishment could have accounts in several banks and credit from different lending institutions. All such data can be pulled out at one single point, for a quick reference check on the individual or commercial establishment seeking a loan.

This helps the lender, be aware of the repayment track record of the loan seeker and quickly decide on loan eligibility. According to the nature of the track record, a borrower is given a credit score. A poor credit score will make getting a loan, a difficult proposition for the borrower.

Individual’s capability to repay the loan he/she has availed. This includes the income and other resources minus other debt payments individual has to pay.

Your credit history is a good indication of your intention to make payments on time. A lender evaluates your intention to repay a loan before lending.

The lender ensures that you can be easily contacted during the tenure of the loan.