Flat rates and Average rates - How to get the best interest rate on Personal Loans in India Padma, an upwardly mobile telecom executive, took a person

Padma, an upwardly mobile telecom executive, took a personal loan of Rs one lakh at a flat interest rate of 11 percent for 36 months to buy a plasma television. Pretty lucky, she thought, to land on this rate when even home loan rates are riding at 13 to 16 percent.

But did she really manage to get it so cheap?

She was yet another customer who got carried away by a rate of interest that does not reflect the actual cost of her loan.

Padma actually would be paying an interest of 20 per cent per annum on a reducing balance basis instead of the 11% that she thought she was paying. Here’s how

With an EMI of Rs 3700, her total payout over 3 years is Rs. 1,33,200 Therefore the total interest paid is Rs. 33,200 (Rs. 1,33,200 less loan amount of Rs. 1,00,000). As the loan period is 3 years the interest payout for one year is Rs. 11,000 approximately, which is 11% of the original loan amount of Rs. 1,00,000/-. This is how the flat rate of 11% is calculated.

This calculation at 11% would have been perfectly ok if she had paid the entire amount of Rs. 1,33,200 at the end of 3 years in one shot. But in actual practice, she is required to pay a monthly installment of Rs. 3,700 for 36 months. Which means with every payment the principal amount of the loan should keep coming down (this is called the reducing balance method of interest calculation or the effective rate of interest)

Flat rate never reflects the actual cost of the loan. The only reason a lender ever quotes a flat rate is because he is ashamed to tell you the effective rate of interest which is very high. UNLESS YOU ARE DESPERATE STAY AWAY FROM A LENDER WHO QUOTES A FLAR RATE ON INTEREST. Even if you are desperate, at least, find out the effective cost of the loan before agreeing to take it. You can use the calculator available by clicking on this link for this purpose.

How to get the best interest rate on personal loans

Flat Rate is humbug

TIP #1: If the lender is offering you a flat rate of interest, avoid it as it never reflects the actual cost of your loan. Always go in for a loan with interest on reducing rate (IRR) where you will be charged only on the balance outstanding. Anything not in writing is worth nothing

Negotiate, and then negotiate some more

TIP #2: Negotiate on the interest rate, processing fees and prepayment penalty with at least three or four lenders. Get all commitments in writing. Discounts on processing fees and prepayment penalties are possible especially if you have salary account in the bank or are using their credit card. So negotiate hard on this.

No upper limit for interest rates, so negotiate hard

TIP #3: Remember banks only have a minimum interest rate that any consumer must pay and the maximum interest rate cap is fairly high. The loan salesmen or DSAs are required to sell loans at a minimum weighted average rate of interest for the money disbursed through them. So they have a natural bias to push customers to higher interest rates to meet their targets. This sometimes inflicts different interest rates for professionals in the same company with similar employee profiles. Be smart and savvy. Don’t be the guy who pays the highest rate but be the guy who pays the lowest rate.

Interest rates vary

TIP #4: Banks have a clutch of varying interest rates, depending on whether the consumer is salaried or self employed. Personal and occupation profiles are also closely scrutinized. Among the salaried, the top ten companies will have lower rates of interest. Employees within each company will have different rates depending on salaries, personal profiles and credit history.

Self employed professionals like doctors and chartered Accountants get much lower rates of interest as compared to self employed non-professional who have to pay a higher rate of interest due to the perceived risk involved in lending to such consumers. So negotiate to get the lowest possible rates for the category you may fall under.

Submit all relevant papers

TIP #5: One must keep in mind that until documents are submitted to the bank, it is most unlikely that a bank would offer its best possible quote. The so-called pre-approved loans are often at a rate that is much higher than what the bank might be willing to live with.

Higher the risk, higher the interest rate

Tip# 6: Personal Loan is an unsecured loan, where the consumer provides no collateral to secure the money. It is often a short term loan sanctioned on the basis of your income and personal networth as a salaried employee or self employed professional.

Due to the higher risks involved, the interest on this product could range anywhere between 14 per cent to 35 percent. It will depend upon the type of consumer and the tenure of the loan. Banks also tend to keep a band of rates, giving customers exotic variations. But it is better to stick to a plain vanilla loan where the interest is calculated on the reducing balance.

Don’t get carried away by a flat rate of interest. Always opt for a loan where interest is calculated on the reducing balance.

Get all commitments on paper.

Banks have a band of rates. Find out which band you fall under and negotiate hard to get the lowest rate

Submit all the relevant documents, only then can you get the best quote from the bank.