5 min read.Updated: 24 Aug 2016, 05:50 AM ISTRashmi Aich
In the short-term, delay in repayment attracts late fee charges, but beware of the long-term repercussions too
We all know at least one person who has had to deal with unpaid credit card debt. It is not pleasant when the your bank calls to tell you that payment is due.
It can happen to the best of us, and most will make the payment soon enough and forget all about the incident. But the bank does not forget. If you apply for a new loan after this incident, your application may be rejected.
“A lot of people are unaware that 30-35% of their credit score is based on repayment behaviour. Casual delays in repayment can dent it, which can take a long time to improve," said Ranjit Punja, co-founder and chief executive officer, Credit Mantri, a credit facilitator.
Loans can be broadly classified into two categories: secured and unsecured. Secured loans are backed by a collateral, such as a house in the case of a home loan. Unsecured ones like personal loans and credit cards are not backed any collateral.
Some people take loans without evaluating their repayment capacity. This leads to sloppy repayment behaviour and affects your immediate financial credibility in the short to medium term. In the long-term it may impact your heirs too.
Let’s look at three effects of poor repayment history.
Penal interest rates
Credit cards: If you are swiping your credit card to buy that latest gadget in the market, make sure you have the funds to fully clear your bill at the end of the billing cycle. Failure to do so will result into the bank levying heavy interest on any outstanding amount the you carry forward to the next cycle.
At up to 48% per annum interest on the outstanding amount, credit card debts are among the most expensive ones around and you should avoid them at all costs. And pay in full. Part payment will cost you heavily too.
Say, if your credit card bill for a month was 20,000 and you paid only 10,000 till the due date. And on the outstanding 10,000, the bank levies a monthly interest rate of 3.25% (39% annually). Here is how your interest will be calculated: 10,000 (outstanding amount) * 3.25% * (12 months * number of days)/365 days. In this example, the interest charged will be 534.25 for the month of default.
This should not discourage you from using credit cards. Just don’t be irresponsible with your card. Pay on time and spend only what you can pay back.
“One should be careful while availing credit. Consider your repaying capacity and future cash flows while taking loans. In this competitive market, lenders are ready to give you loans.... avoid taking loans, if you are not sure of your repayment capacity," said Melvin Joseph, founder, Finvin Financial Planners.
Secured loans: Secured loans such as home or auto have a lower rate of interest than credit cards and personal loans as they have a collateral backing it,making it a bit easier for the lenders to recover their dues.
Banks and other lenders can attach the collateral (the house in case of a home loan) in case of default, and sell it to recover the dues.
“The bank can proceed against the borrower and/or guarantor to enforce personal guarantee, to recover the dues. In case of unsecured loans, the banks can also dispose the assets created out of the loan and file a civil suit.
“In certain situations, such as diversion of funds, criminal action under sections 403 and 415 of the Indian Penal Code (IPC) 1860 can be taken," said Prakash Praharaj, founder, Maxsecure Financial Planners.
Damage to credit score
Lenders prefer those who have a credit history (read: http://bit.ly/2bKRBQA). Not paying your dues on time also impacts your credit score negatively. A credit information report (CIR) contains details of your payments history about loans and credit cards, collated by a credit information company. A person with credit scores of above 750 out of 900 is considered ‘prime’ to offer a loan to.
“There is an increasing reliance by lenders on credit rating scores. Every delay and default is recorded and it impacts your score. Banks use this score to decide whether to lend or not, and if any concessional rate of interest applies to you, or a premium is to be charged," said Lovaii Navlakhi, a Bangalore-based certified financial planner.
Once the score is negatively affected, it takes 9-12 months of good credit record to build it up again.
“There are instances where banks have rejected loan application where the credit score was below 600 (out of 900)... In the emerging global scenario, banks are quoting interest rates based on the credit score, i.e, higher the score, lower the rate and vice versa," said Praharaj.
Heirs may inherit debts
If you don’t settle your loans and liabilities, your heirs may have to bear the burden of repaying them. Therefore, when you are preparing a succession plan for bequeathing your moveable and immoveable assets, it’s important to clearly indicate your outstanding liabilities, i.e., your loans and other liabilities and who would be responsible to pay then off in case of your death. Usually, the primary responsibility of the unpaid loan lies on the guarantor or the co-borrower of the asset that is pledged.
In absence of either of them, “the general rule is that the legal heirs can be held liable for the debt of the deceased, to the extent of their share in the inheritance, if not settled by the estate. However, the liability of legal heirs is typically restricted to the value of the assets in the estate. So, a legal heir may not be legally obliged to repay all such debts," said Prateek Pant, co-founder and head of products and solutions, Sanctum Wealth Management Pvt. Ltd.
In case of secured loans, the banks or lenders engage with the legal heir to transfer the loan to her, so that they she is responsible for it. If the deceased has a Will and the beneficiary is someone other than the legal heir, then the lender has to engage with that beneficiary. In case there is a co-borrower, the responsibility of repayment, including equated monthly instalments (EMIs), lies with the co-borrower, said Pant.
“Credit card outstanding and personal loans are unsecured loans and their recovery depends on each bank’s terms and conditions. But in most cases, banks have the right to claim from legal heirs or successors...," said Pant.
Things to remember
Take a loan only if you can repay. And when you do take a loan, inculcate the discipline of paying on time.
“Ensure adequate funds in your account a few days before the due date," said Navlakhi.
“Do not miss more than three home loan EMIs in a row. This will have a long-term impact on your credit score," said Punja.
Take adequate measures to ensure that your heir(s) don’t inherit your liabilities.
Loans are useful and can help us tide through tough times or fulfil our requirements. But used unwisely, they can also bring on untold misery.