AN IMPORTANT point that has to be considered while taking a loan is the ability of the borrower to actually repay the loan.
There are several points that go into decision making while taking a loan and when it comes to a floating rate loan there are a lot of points to consider.
Long-term loans that run for several years during uncertain times call for planning, but often the most important condition related to the repayment of the loan is not even looked at and hence this requires some attention from existing as well as potential borrowers.
Know the actual amount: The actual amount that is being repaid in the form of the equated monthly instalments (EMIs) actually does not give the right picture to the individual investor.
For example, if there is a loan on which the monthly EMI is Rs 23,450 then this is usually the fixed amount of the EMI or the level amount of the EMI that will operate through the life of the loan.
This amount might seem affordable from the point of the view of the existing cash flow that the loan taker is generating, but there is a lot of information that is being hidden in this area that affects the borrower.
Changes to watch out for: The actual changes that are taking place with respect to a floating rate loan refer to the change in the interest rate due to the change in the rates set by the bank.
This will mean a higher interest rate will be appli cable for the borrower when the rates are rising and vice versa.
In such a situation the change will not be directly visible. This happens because the loan works in such a manner that the EMI amount will not change but the time period of the loan is changed.
This actually leads to a longer or shorter completion period for the loan.
Look out for the impact: The impact of this change on a floating rate loan might not be evident, but there is a large one that is waiting for the individual who has taken the loan.
When the rates rise there is a longer time period for which the loan will have to be repaid and this will mean that there is a larger total amount that has to be paid to the institution from which the loan has been taken.
This puts a higher burden in terms of the amount to be paid and it also translates to a higher amount of interest paid on the loan.
This could be an unsettling experience for people who were expecting their loans to get over quickly and hence they might get frustrated and there could be a long time before they are able to overcome this debt amount.
Keep a safety margin: There is a need for every individual borrower to do some planning before they actually take a loan because this will help them in the entire process.
This involves maintaining a margin of safety that would ensure that even if interest rate on the floating rate loan rises, this would not disrupt the overall planning process.
The best way to do this would be to take a loan with the expectation that the rates would rise at least 1.5-2 per cent from the levels at which the loan has been taken.
When this is done then the chances of a positive surprise increases because in case things work out well and the interest rate remains low then there would be a quicker ending to the loan but if things do not work out well then this is also well planned for.
Happy Investing!!
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