Personal loans have been growing at a very fast rate and the growth has stayed high in January despite the Reserve Bank of India (RBI) increasing risk weights on such loans.
Personal loans are not a very good idea for two reasons.
First, they are easy to get and require minimum paperwork. Second, since they are unsecured loans, they come with a high rate of interest.
Which makes it more difficult to pay off.
For example, getting a personal loan of Rs 5 lakh may be easy if you have the required income but it would mean paying an interest rate of Rs 11,364 every month for five years and the total interest component would almost be Rs 2 lakh.
For a bank, it may be lucrative to give you a personal loan, and hence it is a product that is prone to being mis-sold.
Recently Shatakshi Singh, based out of Delhi had the RM at her bank sell her a personal loan in a rather innovative way.
She was told that she could take a personal loan but could invest in an FD and gain from the difference in interest on both.
She was told that the loan EMIs would go from the interest earned on the FD.
A Classic Case Of Mis-Selling
This is a classic case of mis-selling because of a very simple reason. The maths just does not add up.
“Banking is based on making money by lending money at a higher rate to borrowers and accepting deposits at a lower rate from depositors.
Therefore, at any point in time, the rate of interest on loans of any kind is always higher than the rate of interest on deposits,” says
Suhas Harshe, money coach at MoniYogi Suhas Harshe, a financial planning firm.
Any bank RM trying to sell a personal loan - which incidentally is an unsecured loan carrying the highest rate of interest - and then simultaneously selling any FD is definitely a case of mis-selling.
Doing The Math
For example, if a client is given a personal loan of Rs 10 lakh for three years which carries a rate of interest of 12.65 per cent per year, then his EMI will be Rs 33,525 per month (or Rs. 4,02,300 per year).
On the other hand, if the same is invested in an FD for three years, he will get a rate of interest of 6.75 per cent per year amounting to interest of Rs 62,500 per year.
Assuming the interest is paid every month, it will be Rs 5,208. The difference is Rs 28,317 which the client is losing every month.
“At no point will the EMIs of the personal Loan come from the interest on FDs since there is a huge gap between their rate of interest,” says Harshe.
Agrees Vishal Dhawan Vishal Dhawan, CEO and founder, Plan Ahead Wealth Advisor, and a Securities and Exchange Board of India (Sebi) – registered advisor,
“The amount you will end up paying as interest through your EMI will typically be higher than the interest earned on deposits. Additionally, there could also be a pre-payment penalty if you try to repay the loan early, so this may not be a good strategy to borrow by taking a personal loan and investing in bank deposits.”
Common wisdom says that if you are earning less return on your investment than the interest you are paying off on a loan.
So putting money in FD to pay off a personal loan is a very bad idea. Singh did not fall for it, and neither should you.
