Cheap personal loan rates are not necessarily cheap

Processing fees, pre-payment charges add to expenses; also low rates not for all

If you receive emails and calls from your bank, or any bank, offering a personal loan at 25 basis points below card rates, it’s probably not because the bank has actually sliced its rate. It is more likely the bank has identified you, based on past transactions, as a potential customer. Such data are easily available thanks to data-sharing by banks and customers using ATMs of any bank.

Banks are focusing on retail loans and, within that, personal loans, given that credit is not taking off in the corporate sector. They are increasingly pushing personal loan products to the retail, no-collateral loan segment. Interest rates on personal loans range between 12.99 and 25 per cent. But most banks could give you a special discount lower than their rack rate, depending on your credit history. Before you decide on a personal loan, keep in mind a couple of considerations.

According to Adhil Shetty, CEO, BankBazaar.com, in personal loans, it is uncertain whether the lowest rate would be available to all customers. “That depends on a whole range of parameters – income, credit rating, various risk factors. The lowest rate offered often need not cover all types of borrowers,” he clarifies. Whether a borrower is salaried or self-employed, the company she/he is working for and her/his professional degree are other factors that influence the rate of interest offered. Unlike home loans, mostly floating and, hence, dependent on the Reserve Bank of India’s (RBI’s) rate action, those for personal loans are fixed for the entire tenure. Hence, any RBI rate cut or increase will not lead to any rise or fall in rates for personal loans.

The reason banks are now pushing personal loans, even cutting rates in some cases, is to increase their share of retail loans, says Mahesh Dayani, country head, retail assets, ING Vysya Bank. Besides, since personal loans are unsecured, banks earn a couple of basis points more than from home loans. “Personal loans are a means of meeting an exigency; that is why people are ready to pay a premium. They are need-based. So, a cut or increase in the interest rate will not matter to borrowers,” Dayani says.

Yashish Dahiya, CEO & co-founder, Policybazaar.com, says while the present rates are the lowest since 2008, borrowers should bear in mind other costs – processing fees (between 0.5 and three per cent) and pre-payment penalties.

On the sanctioned amount, banks charge processing fees for verification, stamp-duty charges for a legal agreement, etc. On a Rs 5 lakh loan, assuming a five-year tenure and interest at 15 per cent, a borrower pays Rs 6,23,976 (Rs 5 lakh principal + Rs 1,23,976 interest). However, while the bank will charge interest on Rs 5 lakh, the amount disbursed will be Rs 5 lakh minus the processing fee. If the processing fee is 0.5 per cent, the amount in hand works out to Rs 4,97,500. If the processing fee is as high as three per cent, you get Rs 4,85,000.  Besides, banks charge a pre-payment penalty, which adds to the overall expense. “Hence, the interest paid plus the pre-payment penalty may be more than the original amount and interest that the borrower was supposed to pay to the bank on repayment,” Dahiya says.