Should you take a loan in the time of a crisis?

Budgeting & Saving


May 7, 2020

The economy of India, as well as the world, is still reeling under the effect of the Coronavirus pandemic even as we are lockdown 3.0. People are struggling to hold on to their jobs as the industrial slowdown is threatening job cuts or a slash in the pay package.

Loans constitute a significant portion of liability for many. Though the Government is emphasizing easing borrowing norms, the question persists – Should you take a loan given the current crisis?

1. The pros and cons of loans

Though loans help you meet your financial needs, they come with an additional interest payment. You are required to pay interest on the amount of credit that you borrow, and this interest is the cost of availing the loan. Thus, when you avail a loan, the EMI that you pay not only constitutes the principal repayment of the loan, it also includes interest payments.

Let’s understand with an example:

Suppose you avail a loan of ₹ 20 Lakhs at an interest rate of 10 per cent per annum for 15 years. The EMI would work out to be approx. ₹ 53,117.61. This EMI would contain interest payments too, and over the loan duration, you would have to pay total interest of ₹ 6,87,056 along with the loan amount of ₹ 20 Lakhs.

This interest payment would be an added burden on you, and before availing the loan, you need to ask whether you can take up this added financial outgo.

2. Should you avail a loan given the additional financial cost of interest payment?

There is no right or wrong answer. The answer is purely relative. Taking a loan in the current crisis makes sense if –

  1. You face a medical emergency and are short on funds to pay for it.

  2. Your business needs a capital boost to remain solvent in this lockdown.

  3. The funds are required to pay for any other expense, which cannot be foregone or deferred like salaries and so on.

These are emergencies for which a loan is a viable option. However, on the other hand, if you are mulling over taking a loan for

  • Upgrading to a fancy set of wheels

  • Investing in a dream home

You can defer the expenditure as it is not very urgent. Since there is a lockdown and you will not be able to execute any of the purchases, it is best you reconsider this decision after the lockdown is over, and the economy gets back on the roll. Till then, it is best to hold on.

Before availing a loan, ask yourself two main questions

  1. Do you need the money?

  2. If yes, then what for?

If the funds are 'really' needed for an expense that cannot be overlooked, you can avail a loan. Else, try deferring the borrowing till after the end of the lockdown when normalcy returns and the economy becomes stable.

While it is true that you can avoid paying EMIs for three months, the fact remains that the interest liability would accumulate over the moratorium period. Moreover, this interest accumulation would also be higher since the loan amount is not reducing through EMIs.

Let’s understand

Suppose the loan amount is ₹ 5 Lakhs, interest is 12 per cent and the tenure is 24 months. You would have to pay an EMI of ₹ 23,537 every month to repay the loan plus the interest in 24 months.

Now, suppose you have already paid the EMI for six months before the moratorium. So, for the remaining 18 EMI's after the moratorium of 3 months, the EMI would be ₹ 24,250 since the interest would keep accruing on the outstanding principal amount.

So, though you are enjoying a repayment holiday for three months, the interest accrues and increases your EMI. You may also choose to extend the loan tenure to adjust the EMI or pay the interest for the three months at one go to reduce the outstanding principal.

There is no effect of the moratorium on your credit score but might cost you more.

3. What should you do?

If you have money saved up for the rainy day, use your savings for meeting your financial requirements. If the savings prove insufficient, try and defer the expenditure till the end of the lockdown. As it is, the lockdown has limited many activities, and it might be possible that you can postpone your expense for a later date. So, assess your needs, savings and try to stay away from financial liabilities if they are not urgent.

Want to know how others in your situation are handling their money situation? Head to the "Investing" circle on the Basis app.

#Loans #EMI #Moratorium

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