- What is EMI?
EMI is short for Equated Monthly Installment is a fixed payment made by a borrower to a lender at a specified date in each calendar month. Equated monthly instalments are used to pay both the interest and the principal each month so that over a specified number of months, the loan is paid off in full.
- What is Set Up EMI and Step-Down EMI?
An EMI can be approached in two ways of Step Up EMI and Step-Down EMI. The EMIs remain constant for a few months before changing either upward (in case of step Up method) and downward (in case of a step down).
Step Up EMI: Paying a higher EMI amount may not be feasible for borrowers at the very beginning of repayment. Hence, lenders may give them the provision to pay a lower EMI amount in the initial years of repayment. Gradually the amount can be increased during the repayment years. Taking a loan can be unimaginable for the younger generation, but a step-up EMI solves this problem. A step-up loan takes into account the future earning potential of the prospective borrower, which makes it easier for them to afford a loan.
Step Down EMI: Step Down EMI is contrary to the policy of Step Up EMI. At times, a borrower at the time of taking a loan may have a stable and good income to make huge deposits as part of his EMI repayments. In such a scenario, rates are huge initially as the borrower can easily afford high EMI repayments. As the years roll by, the monthly instalments come down.
- What is the part of EMI and how the interest payment varies?
EMIs has two main parts, i.e. the principal amount and the interest. The interest is charged on the principal amount, which the borrower has to pay for each month of the loan tenure. In the initial years of repayment of the loan, most of the repayment amount is the interest charged. As the principal loan amount depletes due to the repayments, affecting the absolute interest out go down.
- What is MCLR?
MCLR is short for Marginal Cost of Fund based Lending Rate, which is a form of benchmark that banks use to fix the interest rate on floating-rate loans. The RBI has asked banks to link all the floating rate loans to MCLR from April 1, 2016. Even fixed-rate loans with tenors of up to three years are also priced according to MCLR.
MCLR is calculated by taking into account all the borrowings of a bank. Banks borrow funds from various sources, which include Fixed Deposits (FD), a fund in Savings & Current accounts, equity (retained earnings), RBI loans, and so on. Hence, a bank with operating efficiency and access to the cheap fund can have lower MCLR compared to other banks while banks are not allowed to lend below MCLR.
- What is Repo and Reverse Repo Rate?
Repo Rate, or Repurchase Rate, is the rate at which the Reserve Bank of India lends money to commercial banks in the event of any shortfall of funds. Reverse Repo is the exact opposite of Repo. Banks park money with the RBI for the short term at the prevailing Reverse Repo Rate. The Repo Rate always stands higher than the Reverse Repo Rate, and the spread between the two is RBI’s income.
Repo rate is used as an effective tool by monetary authorities to control inflation. An increase in Repo Rate, reduces the money supply to the economy as borrowing from the RBI become expensive and reduces disposable income and thus arrests inflation. Vice-versa happens when Repo Rate is reduced.
Repo Rate is the most significant rate for the common man too. Everything from interest rates on loans to returns on deposits is influenced by this crucial rate set by the RBI, which is why interest rates on home loans, car loans and other kinds of borrowings go up and down based on the direction of Repo Rate change. Similarly, banks adjust savings account, fixed deposit returns based on this benchmark.
- What is the Prime Lending Rate (PLR)?
PLR (Prime Lending Rate) is the internal benchmark rate used for setting up the interest rate on floating-rate loans sanctioned by Non-Banking Financial Companies (NBFC) and Housing Finance Companies (HFC). PLR rate is calculated based on the average cost of funds.
- What are the Reference Rate and spread?
A reference rate is an interest rate benchmark used to set other interest rates. The Rate of Interest of the floating rate loans is linked to a reference rate. Reference rates are at the core of an adjustable-rate of interest. With this, the borrower’s interest rate will be the reference rate, plus an additional fixed-rate, known as the spread.
From the lender’s viewpoint, the reference rate is a guaranteed rate of borrowing. At a minimum, the lender always earns the spread as profit. For the borrower, however, changes in the reference rate can have a definite financial impact. If the reference rate makes an upward move, borrowers who pay floating interest rates can see their cash outflow payments rise.
The reference rate can be Repo Rate, MCLR or PLR.
- What is the kind of rate of interest charged?
The rate of interest being charged on loan is of three categories depending upon the type of loan being taken by the borrower. They are floating, fixed and hybrid. This usually applies for home loans since repaying the home loan can be quite a task for the borrower of the loan.
- What is a floating rate of interest?
A floating rate of interest is one that is flexible and moves along with the reference rate, and reference rate changes according to the market scenario. Most lenders ask the borrower to opt for floating interest rates since they peg their floating rates to the reference rate. It changes with the changes in the market scenario, so if the reference rate falls, your floating rate will also decline and vice versa. Floating rates are lower than fixed rates. They are adjusted every 3 or 6 months.
- What is a fixed rate of interest?
A fixed interest rate is one that is charged on the principal amount of a loan taken by a borrower throughout the tenor of the loan. A fixed-rate also shields you against adverse movement of Repo, MCLR, PLR or any reference rate. For long term loans, it is preferred unless one has plans to close the loan in the medium term.
- What is Hybrid rate of interest?
A hybrid rate of interest is one that is a combination of both fixed and floating rates of interest. Sometimes, mortgages can have multiple interest rate options. A hybrid rate of interest ensures that the repayment tenure has an interest rate that is made up of both of a fixed rate for some portion of the term and floating rate for the rest. This kind of arrangement tries to shield borrower from an increase in reference rate in medium-term and benefits lowering of reference rate in the long term.
- What is a Term Sheet and how this is the difference from Sanction Letter?
Term Sheet: A term sheet is a bank’s non-binding letter of intent, an indication of their interest in the proposed loan. Term sheets are provided by lenders to prospective borrowers prior to a full underwriting of and credit approval by the lender. When a term sheet is issued to the borrower, it signifies that the bank or the financial institution is interested in the proposed loan. This, however, does not indicate that the loan is approved and is in no form a commitment by the bank. It is more like a sheet that indicates that your loan is taken under consideration positively and can be discussed further.
Sanction Letter: Once the lender is convinced of the borrowers’ credibility and credentials, a decision of acceptance or rejection of loan is taken. When the loan is approved, a sanction letter is issued to the borrower of the loan. This letter is of utmost importance in the entire loan application process right from the application to the final disbursement. This letter is documental proof that the applicant is eligible for a certain amount of loan by the lender. It also includes the Terms and Conditions from the lender. Keep in mind that the sanction letter does not mean a legal approval of the loan. It usually has a validity period between 30 to 60 days from the date of issuance.
- What are the points to be noticed in the Sanction Letter or Term Sheet?
The sanction letter states that the lender is ready to proceed with the approval of a loan and include the following details:
- The total loan amount sanctioned
- Tenure for the loan repayment
- Processing fee and other associated charges
- Applicable interest rates – fixed or floating Rate of Interest (ROI)
- Actual applied Rate of Interest
- Reference Rate for interest calculation
- Applicable EMI or Pre-EMI amount
- The validity period of the sanction letter
- Part-payment and pre-payment charges
- Security asked for
It is to be noted that the sanction letter does not mean a legal approval of the loan. Before disbursing the loan, amount borrower has to submit the further documents and sign the loan agreement. The sanction letter is an important document in the loan process, and it should be kept safely for future reference.
- What does a top-up loan mean?
A top-Up loan is an additional facility that is being provided by the lender to the existing borrowers over and above the principal outstanding. This can be done based on the existing security or by providing additional collateral. The lender relies on good repayment history of the borrower and depletion of the original loan amount. Top up, or enhancement is a cost-effective way of getting additional funding. This is very common in a mortgage loan. A home loan is not eligible for a top-up loan unless the additional fund is required for home improvement.
- What is the renewal of a loan?
Renewal refers to renewing of the existing limit in case of working capital facility or taking on a fresh loan at the end of a previous one. The lender here relies on prompt repayment and account conduct to renew the facility.
- What are the parties to a loan?
A loan agreement is drawn according to the parties mentioned in the Sanction Letter. A loan arrangement may have Borrower, Co-borrower and Guarantor and all these parties could be individual or non-individual legal persons. The borrower is also known as the applicant. Minor, mentally unsound or insolvent persons cannot be part a loan since as per Indian Contract Act, they are ineligible to party to any contract.
- What are the responsibilities of a Borrower?
The primary responsibility of repaying the loan to the lender according to the Terms & conditions laid down in the sanction letter and loan agreement is of the Borrower or Applicant.
- What are the responsibilities of a Co-Borrower?
A Co-Borrower or Co-Applicant is a person who is applying for the loan along with the Borrower / Applicant. Sometimes, paying off the loan can be quite a task for the applicant. Hence, having an additional income as a supplement helps to pay back the loan easily. This is also done to increase the eligibility value of the applicant so that the lender is assured of the borrower’s repayment capabilities. Banks and financial institutions may have few specified relations to be co-applicants. A co-borrower is liable to repay the entire debt with the original borrower whether the borrower defaults or not. Although the principal borrower always undertakes to pay back the entire debt, the co-borrower bears an identical financial and legal responsibility as if they had taken the loan themselves.
- What are the responsibilities of a Guarantor?
A guarantor is an individual or corporate body that guarantees on behalf of the borrower, to repay the debt in the event that the borrower is unable to pay so. He is like a surety ensuring that the loan shall be repaid. A guarantor, too, needs to be with a good credit history and sufficient income for if the time comes to pay the loan amount. A guarantor cannot back out once the loan agreement is signed and sealed until the end of the loan repayment tenure. Moreover, the guarantor is permitted to recover from the defaulting borrower, all the money that has been paid to the lender.
- What is the difference between a Co-borrower and a Guarantor?
The Co-borrower is always liable for the payment of the loan whether the principal borrower pays back or not. If the principal borrower cannot pay at all or starts to default, the lender can request for full payment from the co-borrower. However, a guarantor, is not liable until the principal borrower defaults and the lender has taken all necessary steps to collect the payment. To get the guarantor to pay back the loan, the lender would have to prove that the principal borrower has defaulted.
Moreover, the guarantor is permitted to recover from the defaulting borrower, all the money that has been paid to the lender. But the co-borrower may only recover from the borrower half of the debt they paid to the lender. In addition, a guarantor may be released from the initial contract of guarantee before the loan term ends subject to satisfying conditions stipulated by the lender. In contrast, a co-borrower does not enjoy this privilege.
- What is the role and importance of Partners / Directors / Promoters / Trustees / Society members in a loan structure?
Any lender would like to assess borrowers’ credibility by knowing who is behind the company, that is called as Beneficiary Owner (BO). The actual decision to utilize the funds borrowed by an entity is managed by the Partners / Directors / Promoters / Trustees / Society members, and hence the lender would try to ensure that there is no person with questionable repute or poor credit history in these roles. This not only is a judgement on the intention to repay but also provides some direction whether the company has enough expertise to grow the business and have the ability to repay. Since the ultimate decision-makers are the Partner / Director/ Promoters / Members, lenders insist on taking them as part of the loan structure to ensure accountability of the repayment. A lender can extend loans to the firm, company or trust based on the property of the partners, directors or trustees, respectively.
- What are Ombudsman and his role in loan dispute?
The Banking Ombudsman is a senior official appointed by the Reserve Bank of India to redress customer complaints against deficiency in certain banking services covered under the grounds of complaint specified under Clause 8 of the Banking Ombudsman Scheme, 2006.
A customer can also lodge a complaint on the following grounds of deficiency in service with respect to loans and advances
- non-observance of Reserve Bank Directives on interest rates;
- delays in sanction, disbursement or non-observance of the prescribed time schedule for disposal of loan applications;
- non-acceptance of application for loans without furnishing valid reasons to the applicant; and
- non-adherence to the provisions of the fair practices code for lenders as adopted by the bank or Code of Bank’s Commitment to Customers, as the case may be;
- non-observance of any other direction or instruction of the Reserve Bank as may be specified by the Reserve Bank for this purpose from time to time.
- The Banking Ombudsman may also deal with such other matter as may be specified by the Reserve Bank from time to time.
- How can a complaint be lodged with Banking Ombudsman?
Banking Ombudsman is located at designated places and dispute can be raised to them by the complainee. Ombudsman investigates the complaint filed and decides the correct measures to be taken to resolve the issue. A complaint can be lodged online through RBI portal on to the respective geographical Ombudsman. The list of ombudsmen is available on RBI portal and can be accessed through the following link:
- What is Credit Shield or Loan Shield?
Lenders insist on taking loan protection insurance plan to cover eventualities leading to permanent disability or death of the borrower so that the loan can be repaid without burdening the family of the borrower. This kind of insurance cover is known as Loan Shield or Credit Shield. It is a single premium plan and is of the same duration as the loan term. The sum assured is equal to the loan amount. Here the beneficiary is the lender. Many of the lender fund the premium along with the loan amount and the premium amount get amortized over the loan tenor. Few lenders also bundle the loan offer with health insurance as an added feature.
- What is asset insurance, and how is this related to loan structure?
As a practice, the security mortgaged, hypothecated or pledged needs to be protected from the unforeseeable eventuality like an accident, fire, natural calamities and perils. The borrower must protect the assets offered as security and collateral to the lender. Hence, the loan structure made mandatory to ensure Building, stock, machinery, vehicle or any other assets which have been offered as security or collateral and the insurance need to be assigned to the lender
- What is Balance Transfer and Balance Transfer with Top Up?
In case a borrower has a better offer from another lender, he may transfer his loan from the existing lender to the other. This concept is called the Balance Transfer. Since the outstanding loan is taken over by the new lender, it is named so. Generally, Balance Transfer provides a better rate of interest than the existing and in some cases, a longer tenure than the existing loan.
When the new lender provides additional loan on the same security post taking over the loan is known as Balance Transfer with Top Up. This is widely popular in Home loan and mortgage loan.
When the borrower wants to buy a property from the seller who has mortgaged the said property to a particular lender, in such case, the amount payable by the customer will be adjusted first against outstanding amount of the lender and rest of the amount to the seller. The property to be released from the lender of the seller. In such a case, we have a better option of applying for a loan in the same lender instead of applying in a different lender. This concept is called Seller Balance Transfer.
- What is Business and Non-Business Income?
Business income is the income earned in the ordinary course of business from main operations. It is from the sale of goods or rendering of services. Non-business income is the income earned from non-core operations. It included dividend, interest or rental, etc.
While calculating eligibility, non-business income is given lesser weightage compared to business income. If the non-business income is recurring, the same can be considered as an added comfort for loan eligibility calculation.
- What is Recurring & One Time Income?
One-time income is the income earned out of the one-time activity and not expected to be recurring in nature. It could be capital against; liabilities are written off, profit from the sale of investment or assets, etc. Recurring income is the income which is expected to be occurring in the normal course of business and repetitive. Recurring income is that part of income that the business owner expects to keep recurring even in the future. Unlike one-time income, these are more predictable and can be counted on to be received at regular intervals. All business income is recurring income, and all non-business income are not one-time income. Non-business income can be recurring income also (Dividend, Interest, etc.)
For loan eligibility calculation, non-business incomes are excluded or considered to the extent of recurring in nature for determining the repayment capacity of the borrower. One-time income is not considered for eligibility calculation.
- What is Forex and Speculative Income or Loss, and how are they treated while calculating eligibility?
Forex gain/loss is dependent on currency fluctuations. If the customer is export dominant, then forex is part of direct income/loss; otherwise, it needs to be treated as indirect income/loss. If it is part of indirect income, the treatment is like non-business income and may be excluded from the overall income for calculation of eligibility.
Speculative gains/losses are the outcomes of intra-day trading in the capital market or through derivatives. If nature of business is directly related to broking, trading or hedging, then these are part of direct income/loss, otherwise indirect and are considered to be non-business activity. Thus, affecting the eligibility calculation.
- What Forms of Security Does a lender Need to Provide Security to a borrower?
Security can be created through 4 ways
- What Is Hypothecation?
Hypothecation is the practice where a debtor pledges collateral to secure a debt or as a condition precedent to the debt, or a third–party pledges collateral for the debtor. A letter of hypothecation is the instrument for carrying out a pledge.
- What Is a Pledge?
A pledge is a bailment that conveys possessory title to property owned by a debtor to a creditor to secure repayment for some debt or obligation and to the mutual benefit of both parties. The term is also used to denote the property which constitutes the security. The pledge is a type of security interest
- What Is Lien?
A lien is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation. The owner of the property, who grants the lien, is referred to as the lienee and the person who has the benefit of the lien is referred to as the lienor or lien holder. In other words, a right to keep possession of property belonging to another person until a debt owed by that person is discharged
- What Is Mortgage?
A mortgage loan is the financing against the market value of the property. The property could be residential, commercial, industrial and even vacant site or land.
- An Entity or Individual has not filed the ITR for the Previous Year but has filed before that and recent ITR, will he be eligible for a loan?
Most of the lenders look for 2 consecutive filed Income Tax Returns for extending loan. But as an exception, few lenders may provide a loan based on only one-year ITR provided 3 to 5 years business vintage proof is available. Loan such as unsecured Business Loan is highly difficult to get with non-compliance on return filing status.
It is recommended to file the missed return and apply for a loan as this will considerably improve your chances of approval.
- My Bank Loan has a couple of EMIs that are not paid, what is the option available with me?
When an individual does not pay back their loan and has payments due, they become a defaulter in the eyes of the lender they have borrowed it from. All borrowers are provided with an opportunity and the right to approach the bank in case there is a difficulty in repaying the instalments and in choosing an option to restructure their debt to enable a smooth repayment process.
In difficult times, instead of defaulting on payment, approaching the lenders to find a solution is advisable to maintain a clear repayment history with credit bureaus too.
- What are SMA and my account is classified as SMA, can I get a loan?
Special Mention Accounts (SMA) are those loan accounts that show symptoms of bad asset quality in the first 90 days itself or before it is identified as NPA. The classification of SMA was introduced by the RBI in 2014, to identify the accounts that have the potential to become a NPA Asset.
There are four types of SMA: SMA – 0, SMA – 1, SMA – 2 and SMA – NF.
SMA – 0, the overdue period is between 0 to 30 days.
SMA – 1, the overdue period is between 31 to 60 days.
SMA – 2, account an overdue between 61 to 90 days.
SMA – NF, identified on the basis of Non-financial factors such as delay in renewal or delay in submission of stock statement.
If a borrower’s any of the account is classified as SMA, new lenders will hesitate to fresh exposure. Prolonged SMA status also affects the credit score adversely.
- What is NPA?
A non-performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days. NPAs are further classified as Substandard, Doubtful and Loss assets.
Substandard assets: Assets which has remained NPA for a period less than or equal to 12 months.
Doubtful assets: An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.
Loss assets: Loss asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted, although there may be some salvage or recovery value.
- What is Debt Recovery Tribunal?
Debt Recovery Tribunals (DRT) are established to facilitate the recovery of debt involving banks and other financial institutions with their customers. Under the Recovery of Debts due to Banks and Financial Institutions Act (RDBBFI), 1993 Debt Recovery Tribunals or DRT’s take on loan cases from banks for Rs. 20 Lakh and above.
The main objective and role of DRT is the recovery of funds from borrowers which is payable to banks and financial institutions. The Tribunal has all the powers as the District Court. The Tribunal also has a Recovery officer who guides in executing the recovery Certificates as passed by the Presiding Officers.
- What is SARFAESI?
SARFAESI is short for Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest Act of 2002. This law allows banks and other financial institution to auction residential or commercial properties of defaulters to recover loans without the intervention of the court.
Under SARFAESI, only secured debts, i.e., debts secured by way of underlying assets can be dealt with, and minimum debt amount eligible for recovery under SARFAESI is Rs. 1 Lakh.
- What is the difference between DRT and SARFAESI?
SARFAESI Act is enacted in addition to DRT (RDB Act). Here are the key differences between them.
- Under the RDB Act, Recovery of debts is made through quasi-judicial bodies called Debt Recovery Tribunals. Whereas, under SARFAESI, collateral security can be recovered by the Bank/NBFC itself without approaching any court or Tribunal.
- Under the RDB Act, any debt can be recovered. Whereas, under SARFAESI, only secured debts, i.e., debts secured by way of underlying assets can be recovered.
- Minimum debt amount to approach a DRT is Rs. 20 Lakhs. Whereas, the minimum debt amount eligible for recovery under SARFAESI is Rs. 1 Lakh.
- I have Depreciation Loss – Can I avail a Loan?
If there is only Depreciation loss and Net worth is positive, still a loan can be availed. The loan amount may get restricted.
- I have Business Loss – Can I avail a Loan?
In the case of Business Loss, the business generates negative cash flow; hence the viability of the business is questionable. Few lenders have loan products, which are assessed based on financial factors other than looking into business performances. Such schemes may come handy in such situations.
- What is the repayment Schedule and Statement of Account?
The repayment schedule is the schedule which mentions EMI due dates, EMI bifurcated into Interest and Principal, and closing balance of the loan after each EMI.
Loan statement is the statement which mentions actual repayment of the loan in contrast to the repayment schedule, bouncing and overdue charges and actual balance outstanding.
The banker is keen on looking at loan statement as it reflects the credit history of the borrower.
- I have not filed my latest year Income tax return; will I be eligible for a loan?
In most of the time, getting a loan approved without recent Income-tax Return is difficult. However, few lenders offer schemes under which a limited amount of loan can be availed without submission of Income Tax Returns. The eligibility assessment based on other financial parameters. The loan sanctioned bears lesser tenure and a higher rate of interest as a mitigate to the higher risk taken by the lender.
It is recommended to file the recent Income Tax Returns to improve your chances of approval and competitive offer from potential lenders.
- What is the repayment method available for an EMI based loan?
An EMI can be paid through NACH, ECS or SI.
NACH stands for National Automated Clearing House and is a centralized clearing service created to provide high interbank volume, low-value transactions that are repetitive and periodic.
Electronic Clearing Service or ECS is an electronic mode of funds transfer from one bank account to another. Institutions can also use it for making payments such as the distribution of dividend interest, salary, pension, among others.
SI is short for Standing instructions that the borrower issues the lender. This is a modern, quick ay mode used by many borrowers wherein your bank account is directly debited for the EMI amounts, under your Standing Instructions. Here the lender and the saving or current account provider is the same.
- What is the difference between NACH and ECS?
NACH is a modern and efficient method of repayment. The difference in operation makes NACH preferred method of EMI payment. The differences are
- ECS is a manual process and, takes a lot of time and faces verification issues. In NACH, the workflow is defined, and this helps save much time.
- NACH provides a unique mandate registration reference number which can be used for future reference.
- NACH involves less paperwork, so the rejection ratio is less when compared to ECS.
- With NACH, your payment gets settled on the same day, while ECS takes 3 to 4 days for the same.
- NACH features a dispute-management system, which will resolve your issues easily, while ECS has no such systems in place.
- NACH registrations take only 15 days, while ECS registrations take 30 days.
- What is Inward and Outward Cheque return?
Inward cheque returns mean that a person issued a cheque which got returned due to insufficient funds in his/her account whereas Outward cheque returns mean that a person deposited a cheque received from a third person which bounced back due to insufficiency of funds.
- I have Inward and Outward cheque returns will I be eligible for a loan?
Inward cheque return is the cheque issued to vendor gets bounced, which is very critical for any loan. If Inward cheques returns as a percentage of total debts are more than 2%, chances of getting approval for a loan application is low unless there is a logical explanation. Frequent Inward cheque returns denote, the borrower has cash flow mismanagement and may find difficulty in honoring EMI commitment on the due date.
Outward cheque return is the bouncing of cheque issued by the debtors of the customer, which is not the key determinant of a loan application. However, very high outward cheque returns as a % of total credits (>3%) are always a critical factor while determining the banking health of the customer. This also means the borrower has debtor who has poor commitment level and may turn bad debt at some point in time.
- Can a new company /Startup get a loan?
Most of the lenders look for a business track record for lending. A newly started business or startup fails to exhibit historical business performance, thereby fall short of getting funding under widely known loan products. Understanding this situation and to support the startup eco-system, many Banks and financial institutions offer loan schemes that are designed to fund startups through innovative products such as Factoring or Bills Discounting. Central Govt’s CGTMSE scheme and Growth Capital and Equity Assistance Scheme by SIDBI also play a vital role in finding funding assistance to startups. Few fintech starts up offer funding against digital receivable by newly started entities.