Mis-selling is very common in Financial Sector. I was under impression that it’s is restricted only to Insurance but to my surprise its deep rooted. Mis-Selling of Personal loans is very common. Before we proceed let me add that Mis-selling is the deliberate, reckless or negligent sale of products or services in circumstances where the contract is either misrepresented, or the product/service is unsuitable for the customer’s needs (Source: Wikipedia)
Last Saturday, i visited one of the well known bank to deposit a cheque. Since it was Saturday therefore there was a big queue and suddenly one well dressed executive of Bank approached me. She told me that Bank is offering Personal Loans at special rates under special scheme. I politely told her that currently i don’t have any requirement for Personal Loan. She was a true Salesperson and told me that Bank is offering Personal Loans @ 7.90% p.a. It immediately activated “investor hormones” in my brain. I thought, if i take loan of 10 Lac @ 7.90% p.a. and use this amount to partially prepay my Home Loan (Currently i am paying interest rate of 11.5% p.a. on Home Loan). I can make cool savings of 3.6% p.a. (11.5% – 7.90%) on 10 Lac i.e. 36k p.a. without doing anything . I immediately left the queue and accompanied her to service desk. At the same time, i was confused that if credit is available at such a cheap rate then there should have been queue of 10 Km outside the bank & Why the banks are struggling to sell Personal loan product?
I told bank executive that i need 10 Lac loan for 5 years. She did some calculations on her calculator. She told me that i need to pay approx EMI of Rs 23300 per month and my total interest outflow will be Rs 395263 in 5 years i.e. 79052 p.a. which works out to be interest rate of 7.90% p.a on loan of 10 Lacs. I took all the documents from her including paper on which she wrote all the calculations. She told me that she will deposit my cheque and i need not to stand in queue again.
After reaching home, immediately i switched on my desktop as i was pretty sure that something is missing in this whole game. I opened my EMI calculator & entered the calculations shared by Bank executive. I was shocked to see that interest rate coming on my calculator was 14% p.a. then i understood the entire (mis)calculation to sell the Personal Loan.
I must admit that she has not shared any wrong calculations but she mis-represented the facts which means mis-selling only. She misrepresented or we can say misquoted the interest rate as Simple Interest Rate whereas Interest rate for any Loan instrument is calculated as Compounded Interest Rate. In layman terms in Simple Interest, the principle remains the same for loan duration; whereas for Compound Interest calculation, the principal amount due at the end of the first month becomes the principal for the second month & so on (If loan is on Monthly Rest). As each EMI constitute of Principal and Interest Component therefore Principal component paid needs to be removed from the 2nd month calculation becoz customer has already cleared the portion of principal previous month whereas in Simple Interest it is assumed that Principal outstanding remains constant and customer is only paying Interest Component every month.
To make it more simpler, i will take e.g. of Person A and Person B. Both took loan of 1 Lac for 1 year. Person A took loan on 7.90% Simple Interest and person B took loan on 14% Compounded Interest. Now lets observe the payment pattern of Person A and Person B.
Person A will pay interest of Rs 658.33 every month i.e. Rs 7900 for 12 Months and after 12 months he will return or pay 1 Lac principal back to the lender. What it means, every month he is only paying interest and principal amount of 1 Lac Rs he will pay at the end of 12 months.
Person B pay EMI of 9000 Rs per month and 1 portion of 9000 Rs every month goes towards Principal Payment. He paid approx 1.08 Lac Rs in 12 Months but at the end of 12 month he need not to pay any Principal amount becoz Portion of Principal amount was also getting cleared every month with EMI. Effectively he also paid interest of Rs 7900 only as the Person A only difference is the way Interest Rates are projected in 2 cases. Therefore we observed that Simple Interest of 7.90% p.a. equals to 14% Compounded Interest Rate if Interest is calculated as Compounded Interest but being projected as Simple Interest & another difference is on how Principal is being repaid..
In the above calculation, Bank executive calculated Compounded Interest @ 14% for 5 years on loan of 10 Lacs and then re-calculated the same to project it as Simple Interest Rate of 7.9% p.a. Bank executive took advantage of Mathematical jargon’s to misrepresent the facts. The Poor Customers usually don’t understand the difference between Simple Interest and Compounded Interest but fact of the matter is that Customer is paying interest rate of 14% p.a. Which is the right & correct way to calculate interest rate. All interest rates quoted in financial sector are Compounded Interest Rate only
Above case is perfect e.g. of mis-selling by Banks and on Monday, i again visited the same branch and registered formal complaint with the Branch Manager. I got acknowledgement of complaint from Branch Manager and on Tuesday i couriered the same to RBI. This menace of Mis-Selling of Personal Loans should be stopped and Facts should be represented in correct and rightful manner to the customers so that Customers should not feel cheated.
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