The most common ways of arranging finances is by borrowing against an asset, and the most commonly-owned assets are property, fixed deposits, and gold.
We turn to credit in times of need. However, often there’s confusion on what type of loan to opt for. How do you determine which is the best type of loan for your need? This question is especially pertinent when it comes to selecting the right secured loan.
There are three things one needs to look for while assessing different secured loans to choose the right one: the collateral required, the rate of interest, and the tenor. The most common ways of arranging finances is by borrowing against an asset, and the most commonly-owned assets are property, fixed deposits, and gold. Let us look at loans against each of these in the context of the above-mentioned factors.
There are two ways to get a loan using your property as collateral. The first is via a top-up loan on an existing home loan and the second is a loan against property.
# Top-up loan: You can avail a top-up loan if you have a home loan running with a good repayment track-record. The main condition here is the LTV (Loan to Value). The total balance outstanding after the top-up has to be within the same LTV range at which the loan was issued. For instance, if you were approved for 80% of the property value as a loan, then the total outstanding principal including the top-up can be up to 80% only. If that’s the case, then the bank will extend a top-up on your home loan.
However, “in case your home loan is recent, and the top-up exceeds the permitted LTV, you may not be able to get a top-up. The top-up loan is a good alternative because of the interest rates, which are at par with the home loan rates. You also get a long tenor to repay the loan. Moreover, if you are borrowing to make repairs or refurbish your home, top-up loans also offer you an additional tax benefit. However, the long repayment tenor also translates into a much higher interest payable,” says Adhil Shetty, CEO, BankBazaar.com.
# Loan against property: If you have no home loan running but own some property in your name or hold it jointly with someone with whom you can apply for a loan, you can avail a loan against property. On the plus side, loan against property comes with a longer repayment tenor compared to other personal loans. Depending on the ultimate use of the money borrowed, you may be able to claim tax benefits.
For instance, if you are using the money for business purposes, the interest paid and the incidental costs, such as processing fee and documentation charges, can be claimed as business expenditure under Section 37(1) of the Income Tax Act. But if you are using it for personal reasons such as a wedding, education, or holidays, you cannot avail any tax benefits. On the flip side, the interest rates on loan against property are much higher than a top-up loan. The processing time on a loan against property is also much higher as the lender will have a number of due diligences to complete.
Loans against fixed deposits (FDs) are among the cheapest ways to borrow. Loans against FDs are usually priced 50 to 250 basis points above the relative FD rate. Given that the FD rates are currently averaging 5.5%, you can get a loan against an FD for as little as 6%-6.5%, which is cheaper than a home loan. Most lenders do not levy any pre-payment charges or processing fees. “The only caveat here is that you need to have an FD whose deposit value is at least 10% more than the loan you are borrowing. So, if you need to borrow Rs 2 lakh against your FD, you need to have an FD of around Rs 2.2 lakh. On the other hand, there are no tax benefits on loans against FDs. The tenor for loans against FDs is also very small, usually a couple of years, as the loan tenor cannot exceed the tenure of the FD against which loan is taken and must be repaid before the maturity of the FD,” informs Shetty.
Gold loans are the most versatile and sought-after secured loans. This is because they require very little paperwork for an offline loan and they come with a variety of repayment options. The time required to process a gold loan is very small compared to other forms of secured loans. The processing fee is low and often lenders may not take the income or credit score of the borrower into account while approving the loan. This makes it possible to get a short-term loan very easily.
However, “gold loans can be complex in their own way. Most lenders will ask for at least 18 carat purity, and may charge you a valuation fee. The higher the purity of gold, the higher will be the valuation and the loan amount. Different lenders have different repayment options. Some may allow you to pay the interest every month and the principal at one shot at the end of the tenor. Others may require you to pay a part of the principal every month. Yet others may actually deduct the interest owed when they give you the loan. You need to understand the financial implications of these and choose what works best for you,” says Shetty.
All loans, however, come with consequences if you default on the repayment. In case of secured loans, you may stand to lose your asset in case of default. If you fail to repay the loan in a timely manner, your pledged asset may be seized to recover the outstanding balance. It will also have a negative impact on your credit history and score. So borrow only as much as you need and repay promptly.