Executive Summary:
Personal loan by some school of thoughts is considered to be untouchable due to its many disadvantages, but some amount of financial modeling can make this very product very useful in number of ways i.e. Liquidity, Return, and Availability. By following a model of PL, FD and OD, one can not only have easy access to credit, liquidity, but also earn good rate of return from the same.
Yes, the same is true in financial terms all that we need to make the same happen is some smart planning.
Our elders and many financial planners advice us against personal loans or any other kind of consumption loans, primarily because of following reason:
1. They bear high rate of interest i.e. in range of 16% to 18%
2. Mostly do not lead to asset creation and leads to avoidable expenditures
3. Sucks a part of our liquidity in form of EMIs
4. In case of default, will have negative effect on your CIBIL report
5. Prepayment penalty, even if you want to repay them early
However, even a stopped clock is right twice a day, the same is true with personal loans. These loans have all the above shortcomings, but still are one of the hottest selling products for the day. The reason is the simplicity in obtaining them. For salaried people they are even more simply to obtain and in case of need, they tend to avail the same.
Now let us try to see, how we can use these loans creatively, to make sure they end up earning for us.
Following are the steps that we can follow:
1. Avail a Personal Loan of Rs.1,50,000.00 for a period of 3 Years. The prevailing rate of interest on same is around 16% P.A.
2. Deposit the same in FD. The rate of interest is around 9.75% P.A. for 3 Years
3. Against this FD, take Overdraft. OD can be availed of up to 95% of the FD value. And rate of interest will be 2% higher than the FD rate.
After doing so, let us a see what happens at the end of 3 Years:
1. You would have repaid Rs. 1,89,847.98 as your EMI of the Personal Loan
2. You will get Rs.1,98,291.84 as FD maturity value.
3. This is to say that you got Rs. 8,443.86 Higher than what you paid as EMI of your personal Loan.
Now, entire transaction will result into following benefits:
1. During the entire 36 months, you have liquidity of up to Rs. 1,42,500.00 in your OD Account
2. Your effective rate of interest will be 11.75% PA, which is one of the best rates available after the housing loan rates available at this point in time.
3. The inherent advantage of OD is the applicability of interest rate on daily balance, such that whenever you have surplus amount you can put it in your OD, and reduce your interest liability
4. You can also start transferring your salary in OD Account; this will ensure your ideal cash save interest @ 11.75% instead of earning 3% PA in saving bank account.
5. You do not have to make any upfront investment to make this liquidity
6. In case you are not able to arrange for some EMIs in between, you can avail of the OD facility to avoid any penal charges
7. The major benefit of this model is that, at the end of 3 Yrs, you will end up having cash in hand and that to more than what you have paid in absolute terms.
As in case of all other things, this model is also not without its share of pitfalls, which you can avoid by acting with some financial discipline.
The OD should is an additional liquidity that should be used judiciously in case of need only. When utilized, endeavor should be made towards repayment of the outstanding balance at the earliest. Even if you can keep your salary in this account for some days of the month you will be able to reduce a great deal of your interest cost.
If you intent to use, the OD fully for the entire duration, this model will not be of any benefit to you. Rather you would end up paying 2%-3% more than what you would have paid under simple personal loan.
One can use different investment instruments in this case instead of FD. One example of the same is Gold. With quick and easy loans available against gold, it will also be a good option and going be last few years rate of return on gold, one can enjoy even greater return in case of gold.
Thus, going with personal loan, is a good option, all you need to make sure is that you have necessary financial discipline for the same.
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