Saturday, February 16, 2013

Loans, Banks and Damn Lies

I recently attended a talk on “Financial Planning”, mostly about loans, insurance and retirement plans. Prior to this session, I believed I knew enough about managing my own money. Ah the folly!

For the benefit of those who did not or cannot attend the session, here are a few notes. Hopefully you will learn a thing or two. And to all those with an MBA degree – Please go easy if you don’t find the blog technical enough and resist the urge to throw jargon and formulae at laymen. Comments and corrections are of course welcome.

LOANS:
After months of research, you have finally decided to go with that shiny black beauty and turn up at your bank to process the loan for your new car. The bank claims to have a lesser interest rate than its peers and once the necessary processing is done, you sign on the dotted line convinced that you walked away with a great deal. But did you? The primary components of a loan are Principal and EMI (Equated Monthly Installment). Let’s forget these two (as most will already know) and discuss something a bit more complicated that bankers generally don’t talk about – “Reducing Balance”.

Reducing Balance:
During loan processing, the agent requests you for the monthly EMI payment date. Assuming, or rather hoping, that your salary gets credited on the first of every month, you agree to pay the bank the monthly EMI on the second of every month. Here’s where things get interesting. Even though the EMI is promptly credited on the second, some banks will reduce principal amount only on the 30th of every month. Meaning for around 28 days, the bank gets an interest free loan on your EMI amount. The extra money is called “float” and the golden rule is “DO NOT give float to the bank”.
Some banks used to have half yearly reducing balance tenure- the new age daylight robbery. Ah those evil bankers intent of seven figure bonuses… Thankfully those days are gone and most banks have a monthly reducing balance nowadays. Some banks like SBI have a daily reducing balance, so it does not matter which date you pay your EMI. But if your bank has a monthly reducing balance, ask for the reducing balance cycle period and pay one day before the balance is reduced.
Pages 3-5 of any loan document generally have important details like reducing balance etc. And of course nobody ever reads them.

Negotiations:
There is nothing standard in the world of loans. So always negotiate, whether it is processing cost or prepayment terms.

Flexi Accounts:
A "flexi" account is a savings account linked to your home loan. When you transfer money to it, your principal is reduced by the transferred amount. When money is withdrawn from the flexi account, the interest is now calculated on the original principal. When taking a loan, always enquire if your bank has a flexi account. And remember that as per SEBI, banks cannot charge prepayment amount for closure of housing loan.

Flat Rate:
A sweet sounding female tele-agent calls up and offers a 10% personal loan. You’d immediately jump for it right, knowing that many banks charge as much as 15% for a personal loan? Wrong... Your first question should be whether the interest is a flat rate or not? If yes, your 10% rate is interest is actually around 20% in reality.

Simply put, flat interest rate is based on simple interest rate (calculation based on PNR/100) for the entire amount and a general thumb rule is flat rate * 2 = reducing rate. So when an agent uses the word “flat rate”’, run like your life depends on it; at least you‘ll lose weight.

RETIREMENT SCHEMES:
The best retirement scheme in the market currently is - NPS or New Pension Scheme. Nobody wants to sell an NPS because the margins are very low. If you go to banks and enquire about NPS, they try to sell their own ULIPs to which you should respond with a resounding “No”.

In NPS, the choice of Pension Fund Manager and the investment option rests with the subscriber. In plain English, it means the subscriber can choose who manages the money(LIC, SBI, UTI etc.) among seven competitors and also whether the money goes into equity, debt or balanced. Younger people should have a better appetite for risk, invest more in equity initially and move the yearly interest earned to ‘debt’ section. This way, if the stock markets are down during retirement, a substantial portion of the money remains in ‘debt’ funds which is not subject to market fluctuations. This sort of planning is called STP or Systematic Transfer Plan. 

            Start your retirement plan before you hit thirty. But remember that it’s never too late. Read more about and invest in NPS here: http://pfrda.org.in/

We all know the joke about equity. We invest in the stock market with gusto and when the markets go down – we call it a technical correction. When it falls further, we call it a deeper correction. And when the shares hit rock bottom, we are resigned to calling those shares family property and praying that the market would rise again... So be very careful when investing a lot of money in equity markets. 
INSURANCE:
Life Insurance is term insurance. PERIOD. With insurance, never talk returns, instead talk risk cover. A thumb rule is that your insured amount should be 7 to 10 times your annual pay.

            When buying term insurance from any company check the CSR (claim settlement record) for that scheme. A CSR of 40% means only 40 people out of 100 who claim insurance are actually handed over the money. LIC of course has 100% but you will end up paying a lot more premium because of this. There are some schemes with around 99% CSR and cost a lot less. But if your term insurance scheme has a CSR of 40%, chances are your dependents will never get the money after you die.

There is an innocuous option in term insurance called MWP or Married Woman Protection. If the MWP option is chosen, the insurer's wife is guaranteed to get that money even if debtors attach all his remaining property or assets. The biggest beneficiary of “MWP” option is scamster Harshad Mehta’s wife. Even though Mehta lost all his property and assets after his infamous fraud, his wife got 5 crores after he died due to “MWP” protection and the debtors could never claim that money. Sadly, there's no MMP.
Use policybazaar.com to compare insurance prices. Always go online for most investments since it cuts out the middle agents.

THE WILL:
You’d assume that after you pass away, your insurance nominee would get the money, Right? Wrong. A nominee is not the beneficiary of insurance. He or she is just a trustee in charge of distribution of the insurance amount.

The legal will determines who will get your insurance amount. A Will is an absolute must because if you die without leaving a will and have a house in Raisina Hills beside Lutyens, chances are some evil insurance agency guy is going to file a claim to your property claiming to be a long lost relative. The insurance amount will not be disbursed until this claim is settled in the civil court. In India, that can easily take more than a couple of decades and chances are all your descendants will be dead by the time the verdict arrives...

BANKS:
If you have a lot of money in the bank savings account, you are doing it wrong. DON'T LET money rot in the banks; rather invest in liquid mutual funds. Money invested can be withdrawn with just a day’s notice and investments are safe as they invest in govt. treasury. More importantly they give 8 % interest, better than any savings account returns out there.

Also some banks like Yes and Kotak give around 7-6% returns on their savings account, a lot more than the usual 3-4% of other banks. So yes; open a “Yes” Bank account. Remember that Savings account interest up to 10000 Rs is not taxable (thanks to Pranab da).

To conclude, I would once like to thank the trainer for an enlightening lecture about things I should have known a decade ago. Please be advised that very little of the above financial advice is actually coming from me; so you should be safe!! And finally the usual disclaimer – “If you use the above and screw up, you can’t sue me. Promise…"

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