Lowest Interest Rate on loan may not always be the best deal
Planning to buy a car? When you take a loan, make sure you understand how the interest rate on the loan is calculated Lenders offer loans with different terms and conditions and the lowest interest rate may not always be the best deal.
The flat rate of interest is a widely used trick that creates a financial illusion in the mind of the borrower. The flat rate is arrived at by dividing the total interest paid on the loan by the number of years. It will obviously appear lower than the interest rate calculated on a reducing balance basis. What the borrower does not realise is that he is being charged for the entire loan amount even though the outstanding amount reduces progressively with every EMI. A flat rate of 10% is a lot more expensive than a normal reducing rate of 12%.
Another trick is to ask for one or two EMIs in advance. This seemingly innocuous clause pushes up the effective interest cost for the borrower. This is because the actual loan disbursed is reduced by the amount of these advance payments even though the borrower is charged for the full amount. A loan at 9% with one advance EMI will actually cost the borrower more than 18%. Similarly, two advance EMIs will push up the effective cost of a three-year loan to a prohibitively high 20%.
In a new trend, some banks are insisting on the borrower parking some money in a fixed deposit with them. The rate of interest offered on these deposits is not very attractive but some borrowers have no choice. They are forced to agree to the terms and conditions laid down by the lender. This also pushes up the effective interest on the borrowing, though the difference is not as significant as in the case of loans with advance EMIs.
It's best to stick to the normal reducing balance calculation when comparing interest rates. To avoid confusion, ask the agent to quote the EMI per Rs 1 lakh. This normalisation of quotes will help you compare the offers of other lenders.
Home loan borrowers should also watch out for certain misleading tactics used by lenders. They are enticing new borrowers with lower rates, but don't get carried away by these special offers. The catch is that instead of bringing down the base rate, to which all home loans are linked, they just bring down the spread between the base rate and the rate charged to the customer.
Source: ET
Best Regards
Prakash Nair
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