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How to avoid a personal loan

There is a cost involved in this entire exercise of taking personal loan and this will be the high rate of interest that you end up paying. Yamal Vyas gives some other alternative.

india Updated: Apr 18, 2007 22:09 IST
Yamal Vyas

When you need some funds to tide over a short-term requirement, the easiest way to arrange for this is through a personal loan. The money is available quickly and you can use it for what you wish while the next several months will take care of the repayment.

But there is a cost involved in this entire exercise and this will be the high rate of interest that you end up paying. In such times, there is another alternative that will help you in reducing your interest burden.

Personal loan

Individuals can avail personal loans from banks. The key feature of this loan is that it is not given for a specific purpose and hence it does not have to be used for a particular use only — like a housing loan has to be used for purchasing a house or a car loan to buy a car and so on.
The most important issue in a personal loan is the kind of interest charged on the loan. This can range from 12 per cent per annum to even 30 per cent per annum and this is quite a high rate to pay for the benefit. However, most loans settle between 18-22 per cent. The loan is disguised by the smart marketing person as being just 1.2 per cent or 1.5 per cent, except that this is the monthly figure, which they fail to inform you very conveniently.

Loan against shares

As against this if you have some investments, especially shares, and then there is another option that can be considered. There will be several banks willing to lend you against the security of the shares that you pledge with the bank. These are called loan against shares.

The way this works is that the bank will keep a certain margin of the value of the shares and will lend to you for the remaining part. As these are shares, their value can fluctuate quite a bit and hence there can be sharp erosion. Thus, a large margin is maintained by the bank.

This would mean something like 40-50 per cent and would result in the investor getting a loan for the half or slightly larger than half the amount of the market value of the shares. The bank will often insist that the shares against which the loan is taken should be highly liquid and traded regularly on the exchange. All banks have their own lists of approved shares — about 500 companies usually.

The good part of this entire exercise is that a lower interest rate is charged. The current going rate in the market for loans against shares is around 12-14 per cent and this varies according to the bank. This can be further reduced depending upon the personal standing of the customer.

This is far lower than the high amount that is being charged on the personal loan. An additional expense in the loan against shares is a processing fee that varies from 0.25 per cent to 3 per cent. The lower the processing fee, the better it is for the individual. And this is negotiable. So, be aware of that and drive a hard bargain.

Thus, there is an opportunity to reduce the cost of a loan. And in this, the choice of getting a loan against the existing holdings is a far better option than going in for a personal loan where a high amount of interest will have to be paid.

Personal Loans are very expensive

A better alternative for meeting medium term cash requirement is Loan against shares

The difference in interest costs is more than 10-12 per cent per annum

Processing fees on Loan against shares is negotiable

Personal loans should be availed only as the last alternative

First Published: Apr 18, 2007 22:05 IST