Personal loans over the card limit, unless used to retire high-cost debt, would only complicate finances.
Recently, a number of credit card customers received a pre-approved loan mail, from a leading private sector bank. The customer was entitled to a loan over and above his existing credit limit, at 15 per cent on a reducing balance.
Sounds too good to be true, especially in a market where interest rates are on the rise. Also, for those already burdened with expensive debt (such as credit card debt, which charges over 40 per cent annually), this could be a good way to reduce the burden.
|WHAT IS IT?
|* Loan on credit card is a pre-approved personal loan
|* Interest charged is 15 per cent and more
|* Processing fee is minimum sum or a portion of the loan amount
|* Many banks give prepayment facility but at a cost
|* The EMIs will be billed to the credit card every month
However, if planning to use this debt for other purposes, like buying the latest iPad or mobile, things could go very wrong. V N Kulkarni, chief at Bank of India's debt counselling service, explains: “The equated monthly instalments (EMIs) are added on the card, escalating the bill. And, the loan is over and above the credit limit. One will over-leverage himself/herself.” That is, the loan will be treated separately but come as a part of the monthly credit card bill payment.
Bankers said they typically target rotators – ones who pay the minimum or slightly more every month – with such schemes, as it helps such customers reduce their dues at one go. But, if misused, this would worsen your credit score, limiting future chances of securing any credit.
There are similar products in the market which offer a personal loan at a lower rate within the credit card limit. Under one such scheme, if your credit limit is Rs 30,000, you can avail a loan of Rs 15,000 at 17 per cent for one year, 16 per cent for two years and 15 per cent for 36 and 38 months.
Though such schemes can be used to reduce the interest burden and retiring high cost debt, financial planners are not enthused. Says one, Anirudha Hatwalne: “There are other ways of raising cash. A loan against fixed deposits, which cost two per cent above the deposit rate, can work out cheaper.” He even advises using the gold loan route if one does get the right rate. At present, gold loans come at 12-24 per cent.
In the worst case scenario, it is better to retire investments and use the proceeds. Once the debt is paid, you can restart your investments. Ideally, your total instalment-to-income ratio should not be more than 40-50 per cent. Many exceed this limit; as a result, they keep on borrowing to retire earlier loans, a classic debt trap.
Once caught in a debt trap, clearing the clutter isn't easy, as you will have little or no cash in hand. You would have spoilt your track record as well.