Guide to a Home Owner LoanAre you interest in buying a new car, adding an extension to your home or buying new furniture; or maybe you want to consolidate your debts and you do not know where the money will come from.
LOAN GUIDE - TIPS TO HELP YOU, BEFORE AVAILING A LOANby Rajinder Goswami
LOAN GUIDE - TIPS TO HELP YOU, BEFORE AVAILING A LOAN
For a given quality of a product, we want to purchase it at the lowest rate. Remember - loan is also a product and obviously we will like that we get it at the lowest possible cost. Therefore, before availing a loan, a little vigilance can save you many dollars.
So if you are planning to avail a Home Loan, Student Loan or Study Loan, Mortgage Loan, Home Equity Loan, Pay Day Loan, Vehicle Loan or Conveyance Loan etc., here are certain vital tips for you.
THE COST OF A LOAN CONSISTS OF TWO PARTS:
(A) HIDDEN COSTS
(B) INTEREST COST
A) HIDDEN COSTS:
These are the costs about which the representatives of the banks/finance companies are generally silent at the time of selling their product (i.e. loan). But these costs are very much written in the finer prints of the contract you sign with lender. So, it is wise to go through the entire content of documents you are going to sign for availing a loan. Believe me, there will be many points on which you will like to have clarifications from the lenders.
HIDDEN COST CONSISTS OF THE FOLLOWING THINGS:
1. UPFORNT INSTALMENTS:
Some finance companies take certain installments on the first day of the disbursal of the loan. Suppose you have availed a loan of $10,000 and your EMI (Equated Monthly Installment) has been fixed at $410 per month. Now the lender wants you to deposit, say 5 installments in advance. It means you will deposit $2,050 as upfront installments. In this case the finance company has financed you actually $7,950 ($10,000 - $2,050) but the amount of loan on which you are paying interest will be $10,000. The principal amount from your angle is $7,950 but the lender is charging interest on $10,000. So negotiate with the company for not paying any upfront installments.
2. PROCESSING FEE:
Processing fee is the fee charged from the borrower for preparation of documents. Processing fee is generally negotiable and certain companies waive off the entire fee on negotiation. The companies generally reduce the fee if do not waive off the entire fee. So try your best to negotiate on this front before agreeing to avail the loan. It will save you a handsome money.
3. CHECK BOUNCING CHARGES/LATE EMI CHARGES:
If you are not able to pay the monthly installment on time or the checks given by you for repayment of the loan have bounced due to certain reason, the lender will charge a penalty from you. Different companies charge different penalty in such cases. Check out with the competing companies and fix this condition accordingly. If not settled before hand, you will have to shell out as per the terms written in the contract which may be exorbitantly high.
4. FORECLOSURE PENALTY:
Foreclosure means paying back the entire loan before the agreed period. Suppose you have availed a loan and undergone an agreement with the lender to pay off the entire money in 24 equal monthly installments. After 10 months you have got some money from somewhere and now you want to pay off the entire loan to the lender. This is a case of foreclosure. The lender will charge certain percentage on the remaining principal. This is called foreclosure penalty. Certain lenders don't let to pay off the entire money before a fixed period, say you will not be allowed to opt for foreclosure during first 6 months and after that you may pay off the loan that too with foreclosure penalty. The foreclosure clause should be clearly understood and settled with the finance company well in advance. After reviewing your financial credibility, the financer can alter/delete this clause to your benefit. So, do negotiate on this point.
Interest cost is the main cost of the loan availed. Here are given some finer points to be learned about the interest rate component.
INTEREST RATE IS OF TWO TYPES
1. FLAT INTEREST RATE
2. MONTHLY REDUCING INTEREST RATE
1. FLAT INTEREST RATE:-
"Flat interest rate" is the rate of interest that is determined at the time of application and is fixed for the duration of the loan.
Let's illustrate it with an example. Suppose you have borrowed $10,000 @ 4% flat rate of interest for 2 years. At simple interest rate formula, the interest for 2 year comes out to be $800. Now the lender adds this $800 in the principal and calculates EMI for 2 years.
i.e. EMI = (Principal + Interest) divided by number of months
In our example EMI comes out to be ($10,000 + $800) / 24 i.e. EMI will be $450 per month.
Looks to be very simple - Isn't so? But you have borrowed $10,000 and paying interest on $10,800 for all the 24 months.
In reality, the interest burden must reduce every month as the principal is coming down with every installment repaid by you. Here you are paying $33.33 every month ($800 divided by 24) irrespective of the principal amount.
REMEMBER, THE COST OF FLAT RATE OF INTEREST COMES OUT TO BE ALMOST DOUBLE IN COMPARISON TO THE MONTHLY REDUCING INTEREST RATE. HERE IS THE TABLE SHOWING THE COMPARISON BETWEEN THE TWO.
HERE IS THE TABLE SHOWING FLAT RATE V/S EFFECTING RATE
FLAT RATE ========= EFFECTIVE RATE
2.00% ============== 3.70%
3.00% ============== 5.49%
4.00% ============== 7.29%
5.00% ============== 9.09%
6.00% ============== 10.89%
7.00% ============== 12.69%
8.00% ============== 14.49%
9.00% ============== 16.19%
10.00% ============= 17.99%
11.00% ============= 19.70%
12.00% ============= 21.50%
15.00% ============= 26.60%
18.00% ============= 31.70%
20.00% ============= 35.10%
24.00% ============= 41.70%
30.00% ============= 51.40%
This type of interest rate is prevalent in Auto Financing and Cash/Payday/Personal Loans etc. Looking at the above facts it is always advisable to go for monthly reducing interest rates. The effective cost of flat rate is quite higher than what is looks to be. For example the effective cost of 11% flat rate comes out to be 19.70 % - quite a high cost indeed!
MONTHLY REDUCING RATE:
This is the rate which is most cost effective. You should try your level best to borrow only at this rate. Under this rate, the actual amount of loan availed by you is debited to your account and interest is charged on this amount. The interest burden goes on declining with every installment paid by you as with every installment paid, the principal is coming down.
THIS RATE AGAIN HAS TWO VARIANTS
Fixed rate remains fixed throughout the loan period whereas floating rate goes on changing with the rate prevalent in the financial market. If you expect that in future interest rate will rise then you should opt for fixed rate but if you feel that in future the rate of interest will come down then you should go for floating rate of interest. To sum up it becomes evident that some knowledge about the interest rate and some home work done before buying a loan product will help us in saving us a lot of money.
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About the Author
Author is a Banker having 23 years experience in the Baking Sector
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