Cost of loan (House Loan)-1

Andy has left a link to a house loan and “getting rich” article (half cooked) in the comments on my previous post on house loans. Here is the link to the article on rediff.

Now the biggest problem with these kind of HALF_COOKED and useless articles on rediff is that they not only misguide the readers, but also prompt them to buy the books by putting up half the information. Like the title of last part of the article is “Lies, Lies and More Lies” and then it says “This has got to be one of the most insane pieces of advice I have ever come across.”, but it hardly tells anything about why this is insane from the point of view of the author. The only aim of this article is to create curiosity about the book, so that people can buy it. Even the price and publishing house is quoted at the bottom. This is one reason I really hate rediff – half cooked, incomplete, marketing articles, leading to indirectly misguide the common readers.

Now my knowledge tells me that taking loan is perfect – use other people’s money and generate income for yourself.

So, Debt is good – but only sometimes.

Let’s take an example.
I am running a shop. I need money to buy goods at wholesale price and then sell them off at retail price to earn money.

To get the money from a bank as a loan, I need to get into lot of formalities – Income tax returns, insurance, stamp duty, etc. So what I do is take the money from market. There are still many lenders (Sahukaars), who are offering loans (though maybe illegal) to individuals in open market. The simple terms and conditions for loans are individual relations and reputation. The loan is offered on simple terms. X gives 100,000 to Y as a loan, and Y has to give back 1.5% each month as interest. Whenever Y has sufficient money, he returns the entire 1 Lakh and the loan ends. If Y has part money like 50,000 he returns that and interest of 1.5% is given only on remaining 50,000 of loan. The income to the lender is the interest of 1.5% that he gets each month. No insurance, no documents required. Simple and straightforward.

This is what goes on in local markets and retail businesses in towns and cities. I’m not sure if this lending business is legal.

Let’s take an example. I need 60,000 to start my shop. I have good reputation and relations with a neighbouring person who is willing to lend me money for 1.5% per month. I take 60K from him and start paying him 1.5% * 60K = 900 Rs. to him each month. This goes on for 1 year. After 1 year, I have generated 40K and I repay that money to my lender. Hence, from that month onwards, I pay an interest only on remaining 20,000, i.e. 20K * 1.5% = 300 Rs. At the end of 6 months, I repay him the remaining 20K, and my loan ends.

So the lender received a total of 900 *12 months + 300 *6 months = 12,600 Rs. as interest over the 18 months duration.

Continue to Part II