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Monday, May 11, 2009

Why Retail Overdraft Accounts are better than Personal Loans?

I am sure all of you are aware of Fixed Deposits where you pledge your money to a bank for a fixed amount of time and earn a rate of interest on the same. Most Middle class Indian families have some amount locked in fixed deposits. However, very few people are aware that these deposits can help them get liquidity on a later date at an affordable rate of Interest.
I have 2 lakhs locked in a fixed deposit which fetches me 9% p.a. Now I need some cash to buy a Car for example a TATA Nano which costs in the range of Rs.125,000 to Rs.130,000. Most people would prefer to take a vehicle loan which will cost anywhere between 14% p.a. to 16% p.a.
A better option would be to go to the bank where you hold the fixed deposit and ask them for an Overdraft against the Fixed Deposits of 2 lakhs. Most Banks (especially the Indian Banks) sanction an OD Limit of upto 90% of your Fixed Deposit Amount, at an Interest Rate which is 1% to 2% more than your Fixed Deposit Interest Rate. So I would be eligible for a Loan of Rs.180,000 at 10% p.a. The best part about this product is that the Interest is charged on a daily average balance method and I pay interest only for the days on which I borrow the money.
This has the following benefits.
1. In a Personal Loan, I predecide the tenor to be 12 months or 24 months and as a result, the interest gets calculated upfront and gets baked into the calculation. The pre-closure charges are heavy and there may be an hefty pre-closure fee as well
2. In the Overdraft, I write out a cheque of Rs.125,000 for my Nano car. After a month I get my salary of Rs.50,000 (or any cashflow) which I can temporarily park in this account. When the Interest is calculated for the month, I save interest to the extent of this amount.
3. In the overdraft you effectively get charged an interest rate of 1% or 2% only, as you continue earning money on your Fixed Deposits and do not need to break the same.
Due to some technical reasons, I am unable to post an Excel Model to show how much Interest you save, however feel free to write to me at the address mentioned below and I will mail the same to you. For any queries on Overdraft accounts or any questions you have in the personal finance domain, do feel free to write into Ask.Pranav@Gmail.Com. I will revert to your query within 48 hours.

Thursday, May 7, 2009

How Credit Card Balance Transfers are Useful?

Balance Transfer is a feature offered on a Credit Card where you can transfer the Balance of one Credit card to another at a lower Rate of Interest. To explain Balance Transfers further, I will need to delve a bit deeper into the concept of Interest Charging on Credit cards.

When you spend on your Credit card you get between 20 to 50 days of an interest Free Period after which you are expected to repay the entire amount. Alternatively, you can choose to pay back only 5% of the balance and pay interest of ~45% per year on the remaining balance. This is a frightful amount of interest you need to pay as compared to conventional products such as Personal Loans etc.

However with the increased competition in Credit Card issuers and their desire to get more customers to use their Cards they have introduced the concept of Balance Transfers which I will explain with the help of an example.

I have an ICICI Credit Card with a limit of Rs.1,00,000 and I have used it to pay Rs.75,000 for my Holiday in Spain. My payment is due on 25th May. I have also been issued a fresh new Yatra Barclaycard Platinum (which I got without doing much when I booked a ticket on Yatra) with a Credit Limit of Rs.150,000. I just call up the Barclaycard Customer Service helpline and ask them to do a Balance Transfer of Rs.75,000 to my ICICI Bank Credit Card. They issue me a cheque favoring the ICICI Bank Credit Card which I drop in the drop box to make my ICICI Bank Payment.

Bingo …. My Credit card debt has seamlessly moved from ICICI to Barclays where I can enjoy a larger Interest Free period. Most banks offer an Interest Free period of 90 days after doing a balance Transfer. So now till mid September I have a Credit Free period on by Barclaycard. However, I will need to pay 5% Minimum Amount every month.
The obvious question is … why do banks promote this product when they do not make any money on the same. This is because they want customers to activate their credit card and get into the habit of paying and hope that within 3 months they will start doing other transactions on the Card as well, now they have gotten into the habit of paying bills on the new card issued to them.

When you opt for Balance Transfers – please look out for the following.
1.There is a processing fee which is charged between 1% and 3% with Service Tax
2.If you do any other transactions on the new card you will pay interest on the same from Day 1. This means that you cannot use the Card with the balance Transfer for anything else
3.Some banks do not give a 0% Interest Balance Transfer, but rather go for a 0.99% or 1.49%, so please check before availing of the same

I do not recommend Balance Transfers (or any other form of Credit Card Debt) at all, however I must admit that they have helped me overcome a temporary liquidity crises. Whenever you need any amount and do not have the liquidity, but are capable of paying the same within three to six months, then do not go for a personal Loan, a Balance Transfer will be much better as you will not pay any interest except for a 1%processing fee.

Feel free to write to me for any further clarifications that you may require on balance Transfers as a product. My E-mail ID is Ask.Pranav@Gmail.com and I will revert to your query in 48 hours.