The good, bad and ugly of loans!

There are two aspects to everything in life and the same is true in the world of finances. Today loans are easily available for instant gratification. Be it a home loan, a loan to own that dream car or a consumer durable loan to buy the latest plasma TV, loans are available at the drop of a hat.

Just as how life offers many choices and it is up to us what we choose, choosing loans also require financial acumen and intelligence. This is because some loans even though they are your best friends in need, can pull you towards more debts and wreck your financial life.

Here are some pointers that can help your understanding of various loans to ensure you manage your debts in a hassle free manner!

The Three Yardsticks in loan selection:

Here are certain yardsticks with which each loan’s worth must be ascertained.

Utility of the Loan: The first yardstick to ascertain the worth of any loan is its utility. The first question you need to ask yourself is how the loan is going to change or help in your day to day affairs.

For example a car loan would mean you can now travel long distances and thereby save frequent cab charges. Similarly a housing loan could bring a utility that you finally have your own home for self use while a loan for a second home can be utilized as an investment. Since everyone has different needs, ascertain whether you really need the loan or are you just looking for the loan only because it is available and you need some sense gratification.

Cost of Usage: The second significant yardstick to check every loan is the cost of usage. For example, in case you opt for a housing loan, the interest you will be paying comes under the cost of the house. So a personal loan taken at a higher interest for down payment would no doubt further increase the cost of usage.

Long Term Value: The third yardstick to consider is the long term or future value of the asset in question. For example, in case you take up a car loan or a consumer durable loan, the assets are likely to depreciate over time. On the other hand, opting for a housing loan may mean the value of the property increases with time, thus resulting in a higher long term or future value.

Understanding Good Loans:

Loans that help create an asset, or loans that result in increasing the long term value of the asset are bracketed under good loans. For examples property loans if taken at reasonable interest rates with a comfortable EMI can mean you can purchase a property without stretching yourself financially. Over a period of time, you not only create an asset, but also one that is increasing in its value over time.

Education loans are another example of good loans where loans are available to create a personal asset. Since an educated individual is much more likely to get a better job and lead a better life, the long term value of such loans is quite positive. Also, repayment towards the education loans does not start immediately; it adds another positive aspect to the loan. Other loans that qualify under the ambit of good loans include business loans and other project based loans taken by self employed people and entrepreneurs.

Understanding the ‘not so good’ loans:

The ‘not so good’ loans are usually those loans which do not create an asset or even if they do it is a depreciating one. Most consumer durable loans and automobile loans come under the category of such loans. While both may help create some asset like a car or a TV they are, however losing their value in the long run while you are paying an interest over their scheduled price. Many people get lured by interest free consumer durable loans, but one must bear in mind that these loans have high loan processing charges.

Personal loans and credit card loans also come under the category of such loans. They do not create any asset nor do they increase the value. Since both personal loan and credit card loans charge very high interest rates, they should be avoided and taken up only when absolutely necessary or as a last resort.

A Comparison Chart for Various Loan Options:

1. The “good to go” loans- They help in increasing your wealth
2. The “close fast before depreciation kicks in” loans- A friend in need, but get rid of them fast
3. The “avoid if you can” Loans- Choose them only if all other doors are closed

 YOU MAY ALSO WANT TO: Check out how much your EMI adds up to – Home Loan EMI Calculator, Car Loan EMI Calculator, Personal Loan EMI Calculator