Have you ever been a loan guarantor for your friend or relative? Or you have jointly applied for a loan? If that’s the case, you should know that you are equally responsible for that loan and all activities, good or bad, will affect your credit score and report. There are several cases where a person was a guarantor for a loan and it was not paid by the main loan taker. In that case, the credit report of the guarantor will also take a hit. So beware!
This whole concept of “credit report and credit score” is such a big thing these days that we decided to include a video course on this topic under our Jagoinvestor Wealth Club program. You can watch the videos and learn about the concepts of credit bureaus!
Errors in a credit report
Sometimes, there are errors and mistakes in your credit report. Your name, address, repayment status for the loan can be wrong. It might be because of a manual error or it can be a mistake from the bank when reporting. There have been cases of mixing up two individual reports because of the same name or same sounding name. If your credit report has any mistake, the usual course of action is:
1. Contacting the credit bureau - All credit bureaus permit you to raise a request to look at some mistake in your report, called “dispute resolution”.
Once the credit bureau gets your request for correction, it will then contact the respective banks to look into it and if found that you were correct, those changes will happen, but only when banks approve it.
Here’s how to get inaccuracies corrected in your CIBIL credit report
• Purchase your own CIBIL CIR and Score.
• Review the report thoroughly and identify if there are any inaccuracies.
• If you find discrepancies then log in to CIBIL’s Dispute Resolution webpage: http://www.cibil.com/consumer-dispute-resolution.
• Provide your name, address, date of birth, report Control Number (CN) and the nature of the dispute.
• CIBIL’s Dispute Resolution Department will analyse and route the dispute to the lending institutions for confirmation.
Please remember that CIBIL can only make changes to your report, once the lending institutions submit the updated/corrected data.
2. Contact the bank - If it’s a bank-related mistake, then you can also parallelly contact the bank and ask them to report the correct information to credit bureaus.
Never took a loan or credit card?
You still don’t have a credit report and score? There are cases where banks have rejected loan application because a person didn’t have any credit history. Note that a bank is more comfortable lending to someone who has a past history and having no history discourages them to say “Yes” at times to a prospective loan seeker. This is a strong reason why someone who never had any loan should now get one. And the easiest one to get and manage on regular basis is a credit card. Start using a credit card and keep paying your dues on time each month to build a good credit history overtime.
Not getting any loan because of bad credit report or score?
Many people who have a bad credit report and score are now not getting any further loans or credit cards. This is a Catch 22 kind of situation where to get
a loan, you need a good report and score, but to improve your report and score, you need another loan, which you can use and repay on time, so that it builds your credit history.
In this case, the solution is to apply for a secured loan and start using it. For example, you can make a fixed deposit for Rs. 30,000 and ask for a credit card against that fixed deposit. Once you get it, you can start using the credit card and then repay the bills each month on time. Over time, this should have some contribution in increasing your credit score.
Advantage of a good score
1. If you have a really good score, you can demand a lower interest rate.
While this is still not seen in India at this moment, it should eventually become a standard rule.
2. For a person having a good credit score, the processing fees and charges can be waived off by some banks.
3. Many times lenders also waive off prepayment penalty on loans for those having high credit scores.
4. With good credit score one can expect a faster loan processing and treatment with high priority.
Action Time
Fill up the following table, which will help you take some action:
You will apply for your CIBIL credit report and score by (put a date) Your CIBIL score is
Does your credit report have any mistakes?
Is your credit score below 700?
Bonus Tips
• Another reason of keeping a good credit report and score is that a new trend of employers asking for credit report at the time of hiring an employee is coming up in India.
• If you are looking for some loan on an urgent basis and you pay off the past loan to improve your credit score and report, it will take some time to update in your CIBIL report. So what you can do is take an NOC from the credit institution and you can approach your new lender and show them the letter from the previous bank, so that it will update the CIBIL report. This will act as proof that you have paid off your past dues that resulted in a bad score and report.
• Even if you don’t need a home loan or a car loan, it might sometimes be a good idea to take some part of loan to just build your credit score and report. This can be done if you are expecting to apply for some other loan in the distant future. But do it only if you can act responsibly about the debt.
The 9th step in your financial life is to think about your debt repayment. These are applicable to most people.
In the last chapter we discussed how debt becomes an Integral part of your financial life and how it’s impacting your credit report and your future chances of getting more debt.
In this chapter will talk about your existing debt, the loans which you have taken and are repaying them. Loans give us access to many things in our life, which we could not buy if we didn’t take help of debt, and sometimes it persuades us to buy things that we might not have bought in case debt was not available.
We love buying things, if possible by cash; else, we go for loans. At times, it’s not about the desire to buy something, but the necessity. You might lose a job and need money, or at times, you might be low on money and some immediate financial goal demands money for which you either go for a personal loan or swipe your credit card to buy things, without thinking about the future consequences. Another common loan taken by people is an education loan, car loan or home loan. But servicing a loan is a very big commitment.
It’s a promise to keep paying an amount each month to the bank. The burden of debt is constantly in your thoughts. You keep worrying about it and at times, “what if” kind of thoughts keep popping in your mind, especially when we face situations like layoffs going on in office or lingering bad health. We are more worried about the “after effects of job loss” rather than the layoff itself; we are more worried about the “after effects of getting bedridden”
rather than “getting bedridden” itself. The pressure of paying back the liability is huge; people don’t like their jobs, but keep on dragging for the sake of repaying a large debt.
How debt enters our life
For an average person there are many ways debt enters his life. Some are due to his needs, some are due to desires and some are due to family and society pressure. A car or bike loan can be a need for someone and desire for someone. A vacation on EMI might be a desire for someone. A home loan can be due to family pressure even if a person is not ready to make such a huge commitment. A personal loan to spend on a wedding or for some social function can also lead to debt in life. And at times, it can just be a casual attitude towards debt and catering too much for instant gratification that can lead to debt in life. Slowly there comes a time when a person is too much in debt, servicing his loan and paying EMI for various things.
Do you want to get rid of your loans faster?
You like the things you buy by going into debt, but we don’t like the “debt”
itself. We want to get rid of it as soon as possible, some people do not have a mind-set living their life with that kind of burden, they don’t feel free,, they feel somewhere something is controlling them. And if possible, most people want to get rid of debt from their head, as soon as they can! That’s a fact.
Now if you have taken a loan and are paying it back or planning to take a debt sometime soon, this chapter will help you in understanding the loan structure and how it works. We will also talk about the concept of prepaying your loan, before the tenure itself.
Note that this does not mean that a debt is bad always and it’s a right financial decision to get rid of the loan ASAP. We are just talking about an option and those who feel they want to take this option can take it.
I wrote an article on my blog a while ago titled, “Do Home Loans kill Entrepreneurship?” which talked about how a debt in our life has a big contribution in trapping us in a situation where our appetite to take some
risky decision in life goes down due to a loan. Many readers commented on the article and confirmed how it was true for most of them. They wanted to make a switch from one company to another company or from their current career to another career, but could not take such a bold step because they had to service a loan.
Getting rid of a loan faster is extremely important for someone if he wants to take a bold step, while one can argue that nothing can stop a person if he is really committed to achieve something, it can’t be denied that getting rid of a debt burden certainly helps to some extent.
Relation between principal and interest of a loan
When you take a loan, you pay back EMI each month. That EMI consists of the principal amount and interest amount. Most people do not understand the relation between their loan interest and principal. They do not understand how their loan structure is being changed and how each EMI payment is affecting it.
They get a loan for 15-20 years; they get a number for EMI and then keep paying the EMI each month. In case they get a big sum in between, the thought of “prepaying the loan” comes into their mind, some do it, but some don’t. Let me explain it to you in simple terms how things work.
EMI has two components, principal part and interest part.
Each month the EMI number is constant, but the composition of
interest and principle part keeps changing
But before we move ahead, let me ask you this simple question
Ajay takes a Rs. 30 lacs loan at 10% interest for 20 years tenure. His EMI would be around Rs 29,000 per month. He keeps paying his EMIs for 5 years, so he pays total Rs. 29,000 × 12 × 5 = Rs. 17.4 lacs in these 5 years. How much of his debt has reduced from Rs. 30 lacs initial amount?
Some people say his debt has come down by a big margin when they hear that Rs. 17.4 lacs are already paid. But the answer is only around Rs. 3 lacs!
His debt outstanding still is close to Rs. 27 lacs (compared to Rs. 30 lacs in start). If you are surprised, that clearly means you don’t understand how things work. Let’s look in detail.
The EMI formula gives a number that needs to be paid each month. That EMI has two components, principal part and interest part. Each month the EMI number is constant, but the composition of interest and principal part keeps changing, and interest part keeps reducing over time. Also, a loan with high tenure will have high interest component in starting years and only in later years, it will come down substantially. So there are two rules you should understand:
For any loan
Rule 1 - Interest part in EMI keeps going down as years pass.
Rule 2 - Interest part is very high in long tenure loans and small in short tenure loans.
Long tenure loans
Let us take the previous example of a long-term loan. Where the tenure was 20 years, interest was 10% and loan was for Rs. 30 lacs. Now if you see the below chart, it shows you the interest and principal paid in each consecutive 5 years. The blue part represents INTEREST part and red bar represents PRINCIPAL part and the total is the EMI paid in those 5 years, which will be equal in all the 5 years.
You can clearly see from the graph above that the interest component is huge in starting 5 years and it keeps coming down as the time passes. Can you notice that even in 10-15th year also the interest paid is higher than the principal part?
Small tenure loans
In the same way, let’s talk about the short tenure loans, like a car loan or a personal loan, which lasts say 4 years? Let’s assume there is a loan of Rs 3 lacs at 10% interest rate for 4 years tenure. The EMI in the above case would be Rs 7609 per month. Let’s see what happens in all the 4 years.
If you now see the above chart, you will notice that the interest part paid each year comes down, but you will notice that even from the starting years, the interest component was so much smaller than the principal part. This proves that the interest part is small when loan tenure is smaller.
The impact on your loan outstanding
Your loan outstanding reduces by your principal payment part; hence, if the principal part is small, your loan outstanding will reduce by small margin, and that’s the reason that in long term loans, the principal outstanding amount comes down at a very small pace in starting years. This ensures that whatever EMIs you pay will mostly go towards your interest payment.
Prepaying your loan
The interest you pay in any given month is calculated based on your outstanding loan at that point of time. Now when you prepay your loan by any amount, that amount is treated as part of your outstanding loan principal and it’s reduced by that much, which means your loan outstanding comes down. If that happens, your loan tenure goes down considering your EMI is not changed.
Let me give you an example
Let’s take the same example we were looking at. Rs. 30 lacs loan @10%
interest for next 20 years. If you use the EMI calculator, you can find out the EMI is Rs. 28950. But now what are the principal part and the interest part?
It’s very simple.
Interest part for a month = Outstanding - Loan * Monthly Interest
As the interest in our case is 10% yearly, we will divide it by 12 to find out the monthly interest.
So for the first month:
= Rs. 30,00,000 * 10%/12
= Rs. 30,00,000 * 10/(100 * 12)
= Rs. 25,000
So for the first month, the interest part is Rs. 25,000 and total EMI is Rs.
28,950. Hence, the remaining part is principal part. So, Principal part = Rs. 28,950 - Rs. 25,000 = Rs. 3,950.
Hence, out of your total debt of Rs. 30 lacs, only the principal part will be reduced not the EMI amount.
So your outstanding amount after the first month will be Rs. 30,00,000 - Rs.
3,950 = Rs. 29,96,050
Now for the second month, your outstanding loan will be Rs. 29,96,050 and you will repeat the same process which we did right now. Get the interest part for 2nd month and then reduce it from the EMI amount, and get the principal part. And keep doing that to get the full schedule of the interest and principal part for all the 20 years. In case you do a prepayment in any given month,
you can directly reduce the outstanding loan amount by that additional payment.
I am sharing the first 20 months of schedule, which will help you understand how it looks like
So now, you can see that how the outstanding value comes down by each passing month and it’s only the principal part, which is reduced each month, not the full EMI amount.
So how much does a prepayment affect your
loan?
With this information, now you can understand in a better way the effect of prepayment on your loan. You know that at any point of time, your interest part is calculated on the outstanding amount, and any big reduction in outstanding part will lower the interest part and as EMI is constant, the rest of the part will be principal which will increase now; hence, the loan tenure will come down now.
Taking the same example, Rs. 30 lacs loan @10% interest for 20 years tenure. Let’s say you have paid your EMIs for 5 years, now you will have another 15 years to pay or 180 months remaining and after 5 years your outstanding loan will be approximately Rs. 27 lacs. At this moment, you can prepay some amount. Let see the effect of how tenure comes down, if you pre pay some amount at the end of the 5th year.
If you prepay your loan by amount which is equal to
Your loan tenure will come down by
4 times your EMIs = 1,16,000 16 months 20 times your EMIs = 5,80,000 64 months
Rs 8,75,000 90 months (loan will finish in
half tenure)
See the last example in the above table. At the end of the 5 years of your loan payment, your loan outstanding is Rs. 27 lacs and you need to pay for 180 more months. Now imagine you got a big lump sum amount of Rs. 8.75 lacs from somewhere and if you use it for prepayment, your loan will be finished in just 90 months, a reduction of 50% in tenure. Won’t you like that?
Even if you prepay the loan by just Rs. 1.16 lacs, which is possible, it will bring down your tenure by 16 months. That’s a great relief to most people.
Clever home loan takers do exactly that, as soon as they get any small or big amount of money, they use it for prepayment of their loan and by doing this constantly over some months and years, they finish their debt much before the scheduled debt tenure. Sometimes even in just 4-6 years!
So the key learning is that a small amount prepaid brings a big reduction in the repayment tenure. This understanding is very critical to plan for your debt repayment faster. So by now you have understood this point that prepayment has to be done whenever possible, even a small amount towards principal over a long time repeatedly would bring down the tenure a lot.
Now let’s discuss few points for you to ponder on how to generate money for prepayment. These points will not be true for everyone, but let’s at least see if you can do any of them.
5 Tips for pre-paying off the debt faster