Personal loans can cost less

From Sify India

Have you ever wondered why you need to pay an interest of 16-25 per cent on personal loans, when interest on home loans in only 10-14 per cent?


The justification that loan issuers give for these high interest rates charged on personal loans is that there is no need to specify the purpose for which the loan is required. That is, however, not really the case.

The interest rates on personal loans are much higher, mainly because there is no collateral, i.e. the bank does not have anything to sell off and reclaim the loan in case a borrower defaults. Hence, defaults tend to be more common in the case of a personal loan.

The risk of default is built into the interest rate being charged by the bank. So, individuals who repay the personal loan effectively end up paying for those who don't.

In a home loan, if the borrower defaults, the bank can sell the house and claim its portion of the funds. Similarly, in case of a car loan, the car can be recovered and sold. Having said that, there are ways in which a borrower can take a loan, use it for personal purposes and avoid paying an interest as high as that placed on personal loans.

One such way is to take a loan against a fixed deposit (FD). Ratnesh Kumar, manager of retail banking at Axis Bank, says, “When one takes a loan against an FD of a bank, the bank can liquidate the FD in case the borrower defaults.”

Given this, the rate of interest charged on a loan against an FD is in the range of 9-12 per cent. This is less than the interest rate charged on personal loans. Hence, if you have a fixed deposit and you do not wish to break it, you can use it to get a loan from a bank.

Murali Natrajan, head of consumer bank at Standard Chartered, says, “It also raises a question: 'if I have the money then why do I need a loan’. But such loans can be taken if the borrower doesn’t want to break the FD and pay penalty on premature withdrawal.”

All loans offered against a collateral turn out to be cheaper than a personal loan. Therefore, show the bank that you’re not a defaulter. Tender a security, which the bank knows it can claim if need be. Banks will willingly give you a lower rate, as they are assured that you will pay off the loan to recover the security tendered. Such loans can be asked for by tendering LIC policies, National Savings Certificate (NSC), RBI Bonds, gold jewellery, fixed deposits, shares and debentures and some even accept mutual funds as security. “When one asks for a loan against an NSC certificate, the bank will send it to the post office from where it is issued. The post office will mark it in their books and confirm the NSC,” says Kumar of Axis Bank.
Along with the lower interest rate, the processing charges for loans against security (up to 0.5 per cent of the loan amount) are low as compared with that of a personal loan (1-2 per cent of the loan amount). Then why, in spite of the low rates offered, are such loans unpopular? The fact is that banks are not actively promoting such loans. “Such products were popular even when banks were not offering personal loans,” says Natrajan. Maybe its time, they made a comeback.