Loan in any form is not good for financial health of an individual specially low value loan. I don’t believe in Good Loan or Bad Loan, it should be avoided (If possible). Rather i believe in credit discipline and good credit practices to improve CIBIL score. I do agree that for an asset like property, an individual cannot be save such a huge amount to buy property without home loan. Barring few exceptions i.e. high value assets, we can manage our finances to avoid low value loan / borrowing. In my opinion, a Loan should be availed if following 2 conditions are fulfilled
(a) Purchase / Buy should be an Asset: An Asset is basically a belonging which should be appreciating in nature and adds value to the wealth of an individual. By this definition, Property is an asset whereas loans like vehicle loan, personal loan for foreign holidays, consumer loan for white goods etc are not assets. Any kind of consumer or personal loan for non assets is not advisable. Lets take example of a car, If you bought a car of 5 lakh through Car Loan then it doesn’t make sense. Considering Interest rate of 14%, cost of car along with interest will be approx 6 lakh plus. As car is a depreciating asset and there is a famous saying in North India that value of car is half as soon as it comes out of showroom. Therefore it doesn’t make sense to avail vehicle loan for depreciating asset like Car, Bike etc.
(b) Value of Purchase: Any low value loan shows credit hungry behavior of a buyer which is true for vehicle / consumer / personal loan. Though mortgage of car / bike is secured loan but point i am trying to make is low value loan. Low value loan impacts CIBIL score negatively. You should avail loan only for high value purchase like Property. Though people avail personal loan for foreign holidays which is also High value purchase but its not an asset there i will not suggest the same.
How Low Value Loan impact CIBIL Score?
Let me clarify that low value loan has no correlation with the income level of an individual. As i quote example of my family friend, who earns Rs 2 lakh per month but his savings are actually NIL whereas someone with a salary of 1 lakh can save Rs 30,000 per month easily. Its a wrong notion that with high income, if you avail low value loan then it will not impact your CIBIL Score. Infact its other way round, if my income reported in CIBIL database is Rs 1,50,000 per month and i avail low value loan of Rs 50,000. At micro level, Its show how pathetic i am in managing my finances and poor state of my savings level.
On the other hand, an individual with salary of Rs 30,000 per month availing low value loan of Rs 50,000 can be justified but it has its own problem. The repayment capacity of person with low income is low therefore probability of default is very high. Low income group lives under hand to mouth situation. Any unexpected expenditure disturbs the monthly budget and Axe falls on EMI of low value loan. In short, its a double edged sword. Any wrong move may permanently close the doors of availing future credit from financial institutions.
As we observed that in both the cases i.e. high income and low income, low value loan impacts CIBIL score negatively. In few cases, i observed that people opt for low value loan just to avail some scheme at the time of purchase. In one of the case, one of my client Ms. Suparna bought washing machine through consumer loan. She is well off but retailer was offering free mixer grinder if purchase was through consumer loan. We should avoid such temptations and strictly follow financial & credit discipline. Any such adventure can impact our CIBIL score.
How to Avoid Low Value Loan?
Through this post, i am not conveying that we should not buy vehicle, white goods like washing machine or should not plan foreign holiday etc. We should plan all such purchases but there is a small change in the plan. Mode of payment should shift from Postpaid to Prepaid. In short, instead of availing low value loan for such purchases, we should save for these low value purchases in advance so that it will not impact our CIBIL negatively. Recurring Deposit is one such blessing in disguise which can help us in short term savings to plan low value purchase. Only catch is that we have to plan in advance. Suppose, i am planning to buy a new refrigeration or Bike during this year at the time of Diwali. Instead of availing low value loan at that time, i can plan now as i have almost 9 months to save. I checked and found that on-road price of a bike is Rs 38000 therefore i set a target of Rs 42,000 in 9 months to adjust any price change. I will open recurring deposit of Rs 4,500 per month for next 9 months at 8.25% interest rate. On maturity, i will receive Rs 41, 908 thus will avoid low value loan at the time of purchase. This approach will have triple advantage
(i) It will not impact my CIBIL Score
(ii) I will not bear the interest cost which is another savings for me i.e. icing on the cake.
(iii) Last but not the least, i avoided low value loan through intelligent savings
You can check return from Recurring Deposit through Recurring Deposit Calculator.
i do understand that it is not that easy but you may think that you have already bought a bike and now paying EMI for next 9 months.
To summarize, borrowers should avoid low value loan as it may impact CIBIL score negatively. It shows credit hungry behaviour and financial un-stability. Loan should be availed only for big ticket purchase which classify as an asset and add long term value to the financial portfolio of the borrower.
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