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Private Lending – Beware of 5 Points Before You Borrow

Private lending is most suitable for the borrowers who don’t have any other option left to borrow. There can be multiple reasons like urgent fund requirement, emergency or loan rejection due to CIBIL Score, Loan eligibility, Income, etc. Whatever be the reason, it is important to understand the concept of private lending before commitment. In almost all the cases, private lending is backed by the collateral of equivalent value. Therefore, private lending is not guaranteed if you don’t have any asset or holding to put up as a collateral.

Private lending is more popular in small town, cities, and villages. I receive a lot of queries from readers on private lending. To be very honest, till date i tried to avoid discussing this topic in detail. The reason being, it is catch 22 situations whether to go ahead or not. I discussed private lending briefly in my post, How to avail Home Loan without CIBIL Score. For a borrower loan requirement or rejection of same because of any reason is a do or die situation. In the case of emergency, as a human tendency, we always take decisions that provide temporary relief. In other words, if there is NO other option left then opt for whatever option is available. I believe that borrower should follow the below-mentioned chronology for borrowing

1. Public / Private Banks

2. Regional / Cooperative Banks

3. Rural / Gramin Banks

4. Loan against assets in hand like insurance, gold,

5. Friends and Family Members or employer (loan against salary)

6. Private Lending

Imp Point: If your loan is rejected say by the bank then you should not apply indiscriminately in the order mentioned above. It is important to understand the reasons for the same. You can decide whether to move to next option in the order or altogether skip some of the options. For example, i applied for a personal loan from SBI and it is rejected because of low CIBIL Score.  In this case, i will directly skip to option no 4. The probability of rejection by cooperative banks and gramin banks is also high. As a borrower if you are at option no 6 i.e. private lending then you should keep following points in consideration

Private Lending – Beware of 5 Points Before You Borrow

1. Higher Interest Rate: Compared to prevailing interest rates, private lending interest rates can be two to three times higher than the interest rates offered by the banks. In some cases, it is as high as 30%. As i understand, the private lending interest rates are decided based on the repayment capacity of the borrower. A borrower with low-income level is paying higher interest rates. The perceived risk is high in such cases.

The irony is that if you are paying the higher interest rate and have low repayment capacity, in this case, you will find it difficult to pay principal component. It is a debt trap and in most of the cases, the borrower loses the collateral. Typically the borrowers are not aware of the interest rates. In private lending, most of the calculations are in absolute terms. For example, for a loan of 1L, a borrower will pay an approx installment of Rs 6000 for 20 months. In this case, the interest rate will be 24%. The borrower will calculate that for 1L he need to pay 1.2L i.e. interest of 20k. Prima facie, it sounds a great deal.

2. Loan Value: I personally believe that private lending should be considered similar to a personal loan. You should opt only in case of personal or medical emergency i.e. for low-value loan requirement. Private lending is not suitable for asset creation because of higher interest rates and collateral. A borrower should not prefer private lending for the purchase of a house, vehicle, gold etc.

I came across cases, the readers borrowed money for marriage of their kids. Normally, the age of a borrower in such cases was 55+. A borrower at this age may find it difficult to repay the loan. Therefore, age should also be the key consideration in decision making.

3. Short Term: Considering all the factors, if no of installments of private lending exceeds 18 to 24 months then you should avoid borrowing. The reason being, you may find it difficult to repay. It also depends on interest rates. If the interest rate is between 15% to 20% then you may extend repayment period up to 36 months.

For a private lender, it is always good to have an extended repayment period. The reason being he will get more interest and secondly, it is difficult to lend or find reliable borrowers. For him, it is a business. Any money lying idle with him is a monetary loss. In some cases, private lenders refuse to lend for a shorter period or may increase interest rate in such cases. You should be beware of such situations.

4. No Grievance Redressal: Unlike lending from banks, there is NO grievance redressal mechanism in private lending. In the case of any dispute where will you complain. You are at the mercy of a lender. If the need arises it is advisable to borrow from private lending companies  instead of individuals. In most of the cases, i observed that lending is only based on oral commitments. If everything goes fine then nothing wrong in it but in the case of dispute it becomes a pain to resolve the issues.

The USP of private lending is NO PAPERWORK but it can be disadvantageous for a borrower. It is always advisable to sign a loan agreement outlining the terms and conditions of the private lending. It can be on a plain paper also. Not many people are aware that any agreement between two parties on plain paper is also legally valid. It is applicable for lending but not always. You should also mention dispute handling process in case of delay in installment, non-payment, the return of collateral etc.

5. Business Loan or Clear Another Loan: These are the two biggest mistakes most of the borrowers commit. It is suicidal to opt for private lending to start or expand a business. Business means uncertainty. If god forbids and things don’t work out as expected then a borrower may find himself in a debt trap.

Lastly, to avail a fresh loan at a higher interest rate to clear existing loan is again not advisable from person finance perspective. If you are finding difficult to repay existing loan from a bank then you can request the bank to restructure your existing loan. A bank can reduce EMI and increase tenure so that borrower can repay easily. It is also feasible in case of mounting credit card dues. You may restructure credit card dues to personal loan.

Words of Wisdom: Private lending is a very popular concept in western countries but it is organized. In India, it is not organized and there is no nodal agency to regulate the same. You always come across news of harassment of borrowers in the hands of individual private lenders. Normally, private lenders are politicians or influential personality of their area. If you are not sure of repayment then it is better to AVOID the same.

Of late, private lending is launched in a more sophisticated way of Peer to Peer lending. It is basically a marketplace. You may find both the lenders and borrowers online. If you have good credit history then you may check online P2P lending. With increasing Bank NPA’s, the banks will go slow on lending. It will directly or indirectly help P2P and private lending. As it is not an organized and regulated sector. Therefore, RISK is always HIGH.

Copyright © Nitin Bhatia. All Rights Reserved.

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