Borrowing money is the first option that comes to mind when we are faced with a medical emergency or fall short of funds for making down payment on our new house. And, the most common form of loan taken at such junctures is personal loan. Now while some may approach a bank or a non-banking financial institution (NBFC), many also contact money lenders. So, the question to be asked is whom should one approach —a private money lender or a bank?
Let’s look at some of the key factors that differentiate loan taken from banks and the one taken from money lenders:
- Loan amount: Lending institutions take into account your current and expected income and repayment capabilities before deciding on a loan amount. Therefore, chances are the amount they sanction might be less than you require. However, money lenders do not conduct a background check and therefore tend to give the exact amount you need. This though may seem a good aspect is actually not as you may be taking a loan beyond your repayment capability, and may get further entangled in a debt trap.
- Interest rates: Money lenders charge higher interest rates than lending institutions. The interest rate on a personal loan ranges from 10.25% to 24% per annum while money lenders lend at a rate of 2%-3% per month.
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- Documentation: Some people willingly approach money lenders as they offer loan instantly with almost zero documentation. Whereas taking a personal loan through a formal channel would require a thorough documentation process.
- Credit history: Another advantage of borrowing money from a bank is that it will improve your credit history/score if you make all your payments on time. Banks send all the information to credit bureaus, such as Credit Information Bureau Limited (CIBIL), which prepare credit history of people, scoring them on the basis of their credit track record. If your credit score is high you can bargain for lower interest rate on future loans. However, borrowing from a private money lender will not be considered in your credit history as it is an informal lending mechanism and is not legally approved.
- Tax waiver: Taking personal loan through financial institutions can also provide you tax benefits, depending on the end-use of the loan amount. For instance, if you have taken a personal loan to fund the purchase, construction or renovation of your home, you can claim a tax deduction of up to Rs 2 lakh under Section 24B for the interest paid during a financial year. (Note tax benefit is on the interest amount and not the principal amount.)
However, if you were to borrow money from a lender there will be no tax benefits. So, if you also include the tax benefits, your effective cost of borrowing will come down.
- Terms and conditions: Another issue when borrowing from a money lender is the absence of a formal agreement. The terms and conditions are hazy and unclear and there is no legal binding. As a result, the money lender may ask you to repay even before the tenure is over or he may increase the interest rate at a whim. But loan taken through a financial institution requires signing of a legally binding agreement which clearly states the terms and conditions related to the repayment tenure, mode of payment, interest rate etc.
So, essentially, this is how it can pan out if you are a salaried or self-employed individual
|
With good credit history |
New to credit |
With bad credit history |
| All banks and NBFCs will be willing to give you loan at good interest rates. | You may have slight difficulty as banks will decide on the basis of your income and geographic location. Some institutions you can consider are ICICI, Kotak, Tata Capital, Bajaj Finserv and Fullerton. | You will have a lot of difficulty in getting a loan. Most lenders will consider your qualification and property assets before approving, which will be at a very high interest rate. |
All in all, I recommend you opt for a loan from a lending institution to meet your financial emergencies and avoid falling into the trap of a money lender.
By Naveen Kukreja
First published in The Tribune