Don't go overboard taking loans just because the lender is generous

While NBFCs are increasingly willing to lend to below-prime borrowers, the latter should remember that failure to repay can have dire consequences

The economic slowdown has taken a toll on the growth rates of secured loan segments, such as home loan, loan against property, and car loan. Credit card borrowings and personal loans are still growing at a robust pace as people turn to them increasingly for emergencies and sometimes even to fund discretionary purchases. An interesting trend that a recent report from TransUnion CIBIL highlights is that lenders, especially non-banking finance companies (NBFCs), have started lending more aggressively to below-prime borrowers.

In the second quarter of 2019, credit-card outstanding balances showed a robust 34.3 per cent y-o-y growth. Personal loans grew 35 per cent. The corresponding numbers for auto loans (10.9 per cent), home loans (14.5 per cent) and loans against property (16.7 per cent) were much lower than their year-ago figures, according to data from TransUnion CIBIL.

Pivoting towards below-prime borrowers: Both, in credit cards and personal loans, lenders displayed a marked shift to below-prime (near-prime and subprime) customers. In Q2 2019, about 32.1 per cent of card originations (giving out of new cards) were to higher-risk customers, compared to 26.4 per cent in Q2 2018.

In the personal loan segment, the average ticket size of loans given out by NBFCs dropped from around Rs 1.1 lakh in Q2 2018 to Rs 41,000 in Q2 2019. “NBFCs are focusing on smaller-value loans to build the consumer base,” says Abhay Kelkar, vice president, research and consulting, TransUnion CIBIL.

The pivot towards higher-risk customers was even more marked in the personal loan segment. About 44.8 per cent of total originations in Q2 2019 were to below-prime customers, compared to 36.4 per cent in Q2 2018. Almost 50 per cent of the personal loans originated by NBFCs in Q2 2019 were to below-prime borrowers, according to TransUnion CIBIL data.

Thus lenders, especially NBFCs, are wooing below-prime customers aggressively. “Lenders have increased their exposure to these borrowers to probably make up for the slowdown in secured lending segments like home loan and auto loan,” says Naveen Kukreja, chief executive officer and co-founder, Paisabazaar.com. Adds Arun Ramamurthy, an expert at repairing borrowers’ credit scores and author of the book, Unlock The Power of Your Credit Score: “Many NBFCs have collaborated with fintech companies. The latter have built alternative scoring models based on which they lend to those who don’t have a credit score or whose scores are poor. The analytics is handled by the fintech company while lending happens through the NBFC’s books.”

The credit score ranges from 300-900. Those having a credit score of 651-700 are referred to as near-prime, while those with scores in the range of 300-650 fall in the subprime category.     

Handle credit with care: This shift means that personal loans and credit cards have become more easily available to borrowers in the below-prime categories. These borrowers need to ensure that they do not over-leverage just because credit is available. “The sum total of equated monthly instalments (EMIs) should not exceed 30-40 per cent of a person’s gross monthly income,” says Kelkar. He adds that those who already have home and car loans need to be cautious that they do not add to their debt burden by taking personal and credit card debt.

Failure to pay personal loan EMIs on time can result in hefty penal interest rates of up to 2 per cent per month. “Borrowers should automate the deduction of their EMIs by setting up standing instructions in their savings account to ensure timely repayment,” advises Kukreja. Credit card holders should only spend what they can repay by their next bill due date. Failing to repay attracts hefty finance charges of up to 47 per cent per annum on the unpaid amount. If the borrower fails to pay even the minimum amount due, he could have to pay an additional late payment fee of up to Rs 1,000.

Credit card users should also avoid exceeding the credit utilisation ratio of 30 per cent (this is the percentage of credit used to total credit limit available on the card). “Exceeding the 30 per cent ratio is considered a sign of credit hunger and leads to credit bureaus reducing the credit score,” says Kukreja.

A payment default by a below-prime borrower will cause his credit score to plummet further. “A poor credit score means the customer will not be able to access any form of formal credit in future,” says Ramamurthy. He adds that today one’s credit score matters beyond loans. Companies look up prospects’ score when considering them for key jobs and directorships.

Reduce debt burden: A person whose debt burden has crossed the prudential limit should take immediate steps to bring it down. One option is to dispose of the liquid assets he may possess for cash. The other is to reduce discretionary expenses, such as expensive holidays, eating out and delaying the replacement of one’s car.     

Those overburdened by debt should also take the debt consolidation route. The best way to do so is to avail of a fresh loan with lower interest rate and longer tenure and use its proceeds to pay off loans that carry higher interest rates. A lower interest rate along with longer tenure will reduce the monthly repayment burden and help avoid penal rates. Those who have availed of personal loans at high interest rates can transfer their outstanding loan amount to another bank at a lower interest rate and longer tenure by opting for a personal loan balance transfer. Similarly, credit card holders who are having difficulty in repaying their entire bill by the due date can convert their dues into EMIs at lower interest rates and for a longer tenure.

Existing home loan borrowers who have multiple loans or large credit card dues can avail of a top-up home loan. These loans have among the lowest rates (8.55-11.95 per cent) and the longest tenures (7-30 years) among all credit options. 

Five tips to improve your credit score

• Pay off all overdue amounts 

• If you have been shut out of normal forms of credit, go for a secured credit card

• Use it judiciously. Avoid using more than 30-40 per cent of the credit limit 

• While your score is low, avoid making too many enquiries for loans

• Such enquiries are seen as a sign of credit hunger and your credit score takes a further beating