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Sunday, January 9, 2011

Personal loan trap: Flat rate no better than reducing one

Placed at the entrance of the office, the big banner proclaimed the USP of the non-banking finance company (NBFC)—“No disclosure of the purpose of the loan.” I was grateful. Despite racking my brains for hours, I hadn’t come up with an urgent reason for a Rs 3-lakh personal loan.

All the options seemed clichéd—illness in family, debtors threatening to sue or capitation fee for a sibling’s education. Weekend doses of potboiler movies were taking their toll. The relationship manger (RM) lived up to the NBFC—not once did he ask why I wanted Rs 3 lakh. The questions were basic.


“Do you own a credit card or have you taken any other loan?” he began. “No,” I replied. My credit record was clean. In fact, I had no record at all. Most investors think this is a good thing. Would the RM let on the truth? He did: “We need to examine your credit record with Credit Information Bureau India Limited for the past one year. If you have no loan or credit card, there is no record. We can’t give you a loan.” I was stumped.

My application had been turned down within five minutes. Where were the false promises to ensure I took a loan? They were coming. The first one was a lame attempt. “Take a credit card. Don't use it if you are uncomfortable. After one year, we will give the loan,” said the RM. What about the emergency for which I needed the money? Would it wait for one year? Of course, I had forgotten.

The NBFC didn’t ask for the purpose of the loan, so they couldn’t be bothered. I murmured something about an emergency and started to get up. “Wait,” ordered the RM. I sat down again. “Does anyone in your family have a credit card? Or has anyone taken a loan?” he asked His second attempt hit pay dirt. I told him that my husband had a credit card and was servicing a home loan. Would that do? “Of course. Take the loan in his name.

What is his annual income?” he asked. I gave a random figure. He tinkered with a calculator and said my husband was eligible for a personal loan up to Rs 6 lakh. It wasn’t his business that my husband’s cash flow could not accommodate another EMI. It was time to ask the most important question: “What is the interest rate on my loan?” The RM excused himself to discuss it with his senior. 
Within five minutes he had the answer: "Your EMI will be Rs 10,696." Alarm bells ought to have started clanging. Instead of revealing the loan rate, the RM was talking about the EMI. Why? I pushed him to tell me the loan rate. He hemmed and hawed but seeing no way out, gave me the figure: 9.45% It wasn't shocking. As expected, the NBFC was charging 7-15% lower interest than banks. This is why people go to them: lesser paperwork and cheaper rates. Also, most don't know the difference between a flat rate and a reducing balance rate.

I wasn't supposed to know either. Continuing to play a naïve investor, I asked: "What will be the rate in the way banks calculate interest?" The RM was not ready for the poser. He stared at me, his computer screen and again at me. Finally, he said reluctantly: 17%. The cat was out of the bag. Banks advertise loan rates calculated on reducing balance, while NBFC's rate was applicable on the entire loan.


In absolute terms, the EMIs would not be very different. I asked the RM to explain why the second figure was higher. "It has been calculated on a reducing balance whereas ours is a flat loan rate. Double the flat rate and you get the reducing rate," he said. In that case, twice 9.45 should be 17, right? Even ordinary investors would have seen through his sham. The RM knew he had messed up. Quickly, he moved to plan B. If you can't convince, confuse. "In a flat rate loan, you have to pay the entire amount if you pre-pay within six months.

In a reducing balance loan rate, you don't have to pay anything except the principle." Did the RM realise he was favouring banks and not the NBFC? Trying to rush, the RM explained the sanctioning of loan. I had to give photocopies of some documents. EMIs would start from 3 February. "So I won't pay anything for the month of January, right?" I asked. The RM's smile slipped a notch. "You will be charged a pre-EMI interest of Rs 10,000 up to 3 February 2011.

I can't set up the direct debit from 3 January as it is only two working days from sanction date (30 December). But don't worry. The amount will be deducted from the loan cheque," he said. What about the processing fee? It was 2% of the loan and would be deducted from the loan cheque as well. I insisted on paying pre-EMI interest and processing fee—totaling Rs 25,000 in cash. But the RM didn't budge.

"We are doing this for you. How does it matter whether you pay now or through the loan?" he asked. It didn't matter to him. I would be the one paying 17% interest on Rs 3.25 lakh instead of Rs 3 lakh.

When I confronted him with this, the RM offered another deal: "If you take this loan from me, I will reduce the interest to 16% and the processing fee to 1.5%." I had to give him credit: He was a lousy RM but a relentless salesman. It is a pity that most people can't make out the difference.

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