Borrowing for Individuals
Question 1: How much should I borrow?
Answer: There is no defined limit for borrowing. Ideally banks and financial institutions lend based on the ability of the borrower to repay but in order to ensure that you don’t fall in debt trap, it is recommended that you should never borrow more than 40% of your gross income. Also borrowing should be avoided for personal consumption. Borrowing should be done only for asset creation as far as possible.
Question 2: Is the borrowing related to level of income of an individual?
Answer: Please note that borrowing is generally linked to ability to repay, however it is also linked to income levels. People with lower income have limited ability to borrow. This happens because they have to spend a significant portion of their income on essential items such as food, clothing and shelter. With increase in income levels, the spending on essential items goes down as percentage of income. This creates larger disposable income.
Question 3: How to decide which bank or financial institution you should borrow from?
Answer: There are various factors which decide from which bank or financial institution an individual should borrow. These are 1) Rate of interest on borrowed money, 2) Tenure of loan, 3) Paper work involved and 4) Service quality. It is also important to check for hidden charges in a loan. Ask bank or financial institution to provide details of all charges. This should be obtained in writing.
Question 4: After borrowing, what are precautions to be taken?
Answer: After borrowing money one must ensure that payment on loan is never delayed. Delayed payments result into delinquency which can have adverse impact on the credit score of an individual making borrowing in future very difficult. It is advisable that modes of payment such as auto debit are used in place of cheques wherever possible. This will reduce the probability of delayed payments due to manual errors.
Question 5: What are precautions to be taken with respect to credit cards?
Answer: Ensure that credit cards are used very judiciously. It is important to avoid demonstration effect. Card usage should be need based and should be done as a replacement of cash payment. It is prudent to avoid card usage in such cases where you won’t have done cash transaction otherwise. If you are not using you card, cancel it and get acknowledgement from the issuer of the card. If a credit card is lost, there is a possibility of misuse.
Question-6: If I have paid all my EMIs, is my loan account automatically closed?
Answer: Answer is both yes and no. Yes, because after paying all your EMIs (Equated Monthly Installment) logically your loan should be closed. But it is important that you talk to bank and obtain a letter of closure from the bank. Banks report loans to credit bureaus and hence if the loan status is not report correctly to the credit bureaus you may issues in future.
Question 7: How important is it to preserve documents related to loans?
Answer: Preserve all documents related to loans with you. The records should be preserved even after loan is closed. This will help in taking up issue with regulator or the bank concerned if any dispute arises in future. You can also keep a scanned copy of document as a backup for reference periodically.
Question 8: My friend is asking me to be guarantor of his loan, should I be his guarantor?
Answer: When you become guarantor of a loan for somebody, you become the borrower as well indirectly. In event of default of the loan by the borrower, the bank will ask you to pay the loan. If you don’t pay loan, this will impact your credit history and borrowing money in future will become extremely difficult for you. So you should never be a guarantor of a loan for somebody you don’t know well and cannot trust completely.
Question 9: Is the date of deposit of cheque, date of payment as well?
Answer: Many people deposit cheque on the last date of payment and assume that the payment has been made. Please remember that the payment is done only when the bank has realized the money i.e. cheque has been honoured. In order to do so, deposit cheque in advance so that the bank or financial institution receives money in advance i.e. on or before payment day.
Question 10: How do I know that I am falling in a debt trap?
Answer: The first indication of debt trap is that you have started delaying payments of loans, unless it is just a one off incident. If you forced to borrow from your friends or relatives to pay your loans because you are not able to pay from your own income source, this is also an indication of the fact that you are now about to get into a debt trap.
Question 11: I have lost my job, what should I do for my outstanding loans?
Answer: It is better to inform you bank or financial institution about it. Also, one should logically try to manage payment of loans by taking help of friends and relatives, if possible. It makes sense to take help of experience credit counselors as well.
Question 12: If I have defaulted in past, will my credit report always remain negative?
Answer: Credit history will not remain negative always even if you my default on any of your loan. It makes sense to regularize payments and clear all the dues. Once you start making payments regularly, credit record will start improving. Credit bureaus use parameters to score an individual. You will need to know them to understand how much time it will take to get your credit score back on track.
Question 13: When should I refer to my credit reports provided by credit bureaus?
Answer: It makes sense to refer to your credit report periodically to identify how your credit performance as per report is. However, it makes sense to check credit report after you have paid your loan completely to ascertain whether it is getting reflected correctly in the report.
Credit Crossroads Series courtesy of Experian