You may have decided to take a loan from a specific bank to start a business or to buy a new house. Your bank may have told you that as soon as you sign a few documents, you’ll have the loan within a matter of hours or days. But have you asked your bank some basic questions? These are issues that banks will not raise on their own – you have to solicit these pieces of information. So, take a look at these questions and see how the answers may impact your cash outflow, either in the form of interest payment or otherwise.
1) Is the rate of interest be fixed or floating?
By default, majority of loans given by banks are floating interest rate loans. That means the interest rate on your loan will vary with the change in the benchmark rate. And if the tenor of your loan is around 10-15 years, you may have to pay a significant sum with the increase in interest rate even by 1%. So, if you want your bank to fix the rate of interest at a particular level, you should ask for it specifically. Some banks even offer a mix of both, i.e., part (amount wise or tenor wise) fix and part (amount wise or tenor wise) floating.
2) How frequently (tenor wise) will the interest be compounded?
The answer to this question enables you to know how you will be impacted when your debt burden increases or reduces because of the compounding factor. Take a look at the following chart and you’ll have an idea:
Periodicity or frequency of compounding on a loan value of Rs. 10 lakh where the rate of interest on loan is 10%
Interest Burden where repayment period is12 Months
Interest Burden where repayment period is 120 Months
Annually
Rs. 1,00,000.00
Rs 15,93,742.46
Half Yearly
Rs. 1,02,500.00
Rs. 16,53,297.71
Quarterly
Rs 1,03,812.89
Rs. 16,85,063.84
3) What are the terms and conditions for pre-payment of loan amount (including penal clauses if any)?
This issue is hardly discussed by bankers though it appears in all bank loan documents in small fonts! You should have this information because of two reasons:
a) Your income and cash flow might have improved and you would like to reduce your debt burden.
b) You have now been lured by another bank (say B) to shift your loan with bank A and Bank B is ready to offer you a cheaper rate. But before accepting the proposal of Bank B, you should weigh the outflow in the form of penalty to be imposed by Bank A.
4) What are the penal clauses in case of delay in payment of installment?
If due to certain unavoidable circumstances you are not in a position to repay your scheduled installment on due date, the bank may apply penal interest. That is, you may be charged extra interest on the full loan amount instead of the default amount.
Say, for example your loan amount is Rs 10, 00,000 and repayment of Rs 100,000 was due last month. The bank charges additional 2%, over and above the agreed interest rate of 10%, for the default period. So, the bank may charge this extra 2% interest on whole loan amount of Rs 10, 00,000 instead of applying it only for the default amount of Rs. 100,000.
5) What other charges (apart from interest payment and loan processing charges) can a bank apply during the loan tenor?
Quite often, banks apply hidden charges on transactions and services. So, the next time you take a loan from a bank don’t forget to ask about charges for certain banking services which you may need during the load tenor. The following indicative list may come in handy:
a) Retrieving of old data/information
b) Getting a balance confirmation certificate.
c) Getting an ‘Interest applied and recovered’ certificate.
d) Getting statements of accounts.
e) Renewal of short term loans (to continue the loan facility for ongoing business requirements).
f) Collection of outstation checks.
g) Replacement of existing securities with another one.
h) Change of interest rate from fixed to floating or otherwise.
Chillibreeze's disclaimer: This is a contributed article and was published on Chillibreeze in February, 2010. The views and opinions expressed in this article are those of the author(s) and do not reflect the views of Chillibreeze as a company. Chillibreeze has a strict anti-plagiarism policy. Please contact us to report any copyright issues related to this article. The relevance of the facts and figures cited (if any) could change after a period of time.
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—About our writer:
Reena, a consultant with MannDeshi Group, an NGO and microfinance institute, has worked with State Bank of India, India’s biggest commercial bank, for 21 years in various capacities {as loan officer to branch head and faculty (of subjects -‘International Banking’, ‘Marketing’, ‘Loan’, ‘Frauds and Preventive Vigilance in Banks’) with State Bank Academy}. She was editor of the academy’s finance magazine. She regularly writes stories, poems, plays, and scripts for a community radio station.
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