There are three questions everyone needs to answer when thinking about loans. Why would you need a loan? When would you need a loan? What sort of loan would you need?
Most borrowers, especially first-time borrowers wait until these questions are pressed onto them, before thinking about the correct answers, at which point their options are severely limited. So in this article, let’s proactively analyze these questions and find the right solutions that will help you plan out your lifetime lending requirements and put yourself in a position, starting today, to secure the most profitable and favorable lending terms when the time comes.
We borrow money for 2 very basic reasons. First, the need for a significant amount of immediate liquidity or capital, for instance, to buy a home. It is inefficient and impractical for any household to be holding that amount of liquid capital, and much more viable to borrow and pay off in regular installments. Second, leverage. Like companies, derivatives traders, and businessmen, it is much more profitable and scalable to use borrowed money when your returns on capital are higher than the interest rates charged by the bank. Most business loans, revolving credit follow this principle. So despite the psychological bias against being in debt, either because of lack of funds or because of cheaper funds outside, debt can be a sound financial strategy when used well and responsibly. The key to this is knowing when to borrow.
The most important part of debt timing is that it either be planned, for instance, if you know you want to be a home-owner one day then your home loan is intrinsically plannable as part of your financial life, or that it be part of a consistent strategy, for instance, sudden windfall opportunities in your business, professional or personal life, cannot be planned but that only means the decision to borrow funds is based on the relative returns and costs of funds rather than the pressing need for funds. Most errors of borrowing are incorrect applications of these two aspects of debt timing.
We are living in one of the best credit market phases. Not only are growth opportunities popping up everywhere and attracting fresh capital, but new technology is also making it easier than ever to quickly and securely avail liquidity. In India, 65% of adults who are under the age of 30, have applied for a personal loan. Personal Loans worth $82 billion were disbursed in the year 2020, growing 23 times higher than just a few years before. Home loan disbursements are even higher. There is significant growth across all the major credit verticals: housing, consumer durable, auto, and retail. So let’s answer that final question: what sort of loan is best for you?
1. Debt Consolidation Loans
A debt consolidation loan simply bundles all existing lines of credit into a single liability that usually offers a lower interest rate, thus reducing the total payments to be made as well as simplifying the payment schedule into a single EMI where multiple loans are needed to be managed before.
2. Home Loans
A home loan is a high leverage loan with a long tenure. In India, in the year 2020, borrowers from the metro cities took home loans worth Rs. 30,00,000 and above on average. The largest lending category, housing loans reached a market size of $290 billion in 2020. Not only is it one of the safest loans, secured against collateral of your property, it is also one that is financially efficient and profitable for most instances. Indian real estate has delivered consistently positive returns for many decades. What’s more, rental demand has increased especially in metro regions such that the average rental returns are higher than the rate of interest on home loans.
3. Education Loans
Education loans worth $12 billion were disbursed in 2020, catering to students pursuing college degrees. These usually cover tuition but sometimes can also include other items. The philosophy of the education loan is basically to look at it as a long-term investment because a college degree is the most statistically reliable way to increase your lifetime earnings. So even though fresh graduates are often saddled with the EMI payments on their loans, the investment in their education pays back many times over.
4. Medical Loans
More often than not, it is hard to anticipate medical emergencies. Without enough savings or proper insurance coverage, it is tough facing these kinds of situations. However, banks and lenders offer medical loans which are also a type of personal loan but only used to pay for medical care.
5. Business Loans
Lenders of business loans hear out the ideas of aspiring entrepreneurs and help kick start their businesses. Similarly, an already established business can receive a small business loan for further growth. In India, a total of $19 billion dollars have been disbursed as business loans from 2017 to 2020. These are based on the financial calculation of leverage discussed before, where the ROI of your venture exceeds the ROI on the business loan.
6. Loan Against Property
A Loan Against Property, or LAP, is a secured loan where commercial or residential property is provided as collateral. This gives LAPs a huge advantage over personal loans and business loans. The interest rates are substantially lower, a much higher amount can be borrowed, and the tenure of the loan can be much longer. The LAP market in India is $68 billion and growing rapidly among both salaried individuals and business owners.
7. Emergency Loans
Covid-19 has brought into sharp focus the financial troubles that can beset us all of a sudden due to uncontrollable circumstances ranging from disruptions in income sources to medical challenges. Banks and several financial institutions provide emergency personal loans to tackle these hurdles. However, the interest rates on these loans are generally high given their relative risk, being unsecured loans.
8. Travel Loans
Personal loans are unsecured because they don’t require any collateral and borrowers do not need to provide details such as why they need the loan. So, it is not uncommon for people to take personal loans for traveling purposes as well. So, should you take a loan to travel? Like all things financial, that depends. A loan is a responsibility, a commitment, but also an investment. So treat debt like you would other investments and commitments and evaluate whether this loan is right for you. It is worth mentioning the interesting case of 71-year-old KR Vijayan and his 69-year-old wife Mohana from Kerala, who traveled the world with the help of personal loans integrated with their savings.
9. Credit Improver Loans
The first checkpoint for any loan application is the credit score. That makes credit a catch-22 situation for many people, especially young adults starting off their careers. Individuals without a credit history, or poor credit history, have limited avenues to build or improve their credit since their score makes them ineligible for loans. Fortunately, there are simple lines of credit that can be used to build or improve credit. Secured credit cards for instance are a great way to generate positive signals with a solid history of loan repayments. India saw a total of $22 billion loan disbursements through credit cards in 2020.
10. Auto Loans
Between the years 2017 and 2020, there was significant growth in auto loans, totaling $50 billion. Adding to this the additional categories of two-wheeler loans and commercial vehicle loans, the total vehicular loans reach $100 billion incremental growth. Auto loans, in general, have lower interest rates, and, being a secured loan, there are cases where individuals with lower credit scores get their loan approved.
These are the key loans you need to consider when planning out your lending requirements. Having read this article, you should be able to answer these 3 important questions,
Why borrow money?
When is it best to borrow?
What type of loan is best for you?
Take just 10 minutes today to answer these questions for yourself, not for today or tomorrow but given your long-term financial goals. Armed with these answers, you will be better placed than 95% of borrowers, to strategize and execute your loan in the most profitable and efficient way possible.