Payment of credit card debts through a debt

A question often asked by borrowers is,” Should I avail personal loan or balance transfer to disentangle from credit card debt?” Short-term debt like credit card can be a convenient source of quick funding but can eventually make a deep hole in your pocket. Remember, the interest rates on credit cards are much higher than that on other loans. But weigh all your options and their consequences before you avail a personal loan or low-interest balance transfer as you run the risk of being debt trapped.

Balance transfer versus personal loans

How can one break out of this viscous circle? Either you should ask your bank or credit card issuer to lower the rate or find out whether you can afford to pay off the debt without opening any new credit accounts. Do a little homework to figure out the right option to protect your credit score and save money.

Although both are possible consolidation options for your credit card debt.

Balance transfers are performed by switching one credit balance over to another credit card, usually for a low promotional rate over a limited time period. On the contrary, personal loans are provided by banks and credit unions and can come in secured or unsecured forms. These loans typically have lower interest rates than credit cards, especially if you secure the loan by pledging an asset, such as your car as collateral.

Selecting which option depends on various aspects. For example, how your debt is currently distributed might limit your options. Even though many credit card issuers allow you to transfer over balances from multiple cards into your new card, not all do. On the other hand, a personal loan is probably the cheaper option.

You might be not found it suitable to pledge collateral against a possible secured personal loan. If you default on your credit card debt, it’s unlikely that the card issuer will sue you and comes after your assets. That changes when you open a secured personal loan; the company does take the asset to recoup its loan if you default.

Whether a personal loan or a balance transfer, both categories are likely to negatively impact your credit score, even if you never miss any payments.
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Secured loan or unsecured?

Every borrower has different financial objectives and priorities in life, and attitudes towards risks. Many consumers often find themselves in a dilemma when it comes to choosing between secured and unsecured loan. However, a lender evaluates a consumer’s credit history before making a loan under either circumstance. Understanding the differences between the two and other characteristics unique to each are mandatory for borrowing money. Want to know – which type of debt is more important for you? Let’s find out…

Secured Debt

Secured debts are tied to an asset that’s considered collateral for the debt. Lenders take on less risk by lending on terms that require an asset held as collateral. As this type of loan carries less risk for the lender, interest rates are usually lower for a secured loan. A prime example of a secured debt is a mortgage, where the lender places a lien, or financial interest, on the property until the loan is repaid in full. If the borrower defaults on the loan, the bank can seize the property and sell it to recoup the funds owed. Lenders often require the asset be maintained or insured under certain specifications to maintain the asset’s value.

Unsecured Debt

With unsecured debts, lenders don’t have rights to any collateral for the debt. Lenders issue funds in an unsecured loan based solely on the borrower’s creditworthiness and promise to repay.  If a borrower fails to repay the loan, the lender can sue the borrower to collect the amount owed, but this can take a great deal of time, and legal fees can add up quickly. Therefore, banks typically charge a higher interest rate on these so-called signature loans. Also, credit score and debt-to-income requirements are usually stricter for these types of loans, and they are only made available to the most credible borrowers. Credit card debt is the most widely-held unsecured debt. Other unsecured debts include student loans and medical bills.

Prioritizing your debts

If you’re strapped for cash and faced with the difficult decision of paying only some bills, the secured debts are typically the best choice. These payments are often harder to catch up with and you stand to lose essential assets – like shelter – if you fall behind on payments.

You might give more priority to unsecured debts if you’re making extra payments to pay off some debt. Unsecured debts sometimes have higher interest rate that makes it expensive to spend a long time paying these off. Even when you’re in debt repayment mode, it’s important to keep up the minimum and installment payments on all your accounts.
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Source: Secondary

Secured credit cards for better benefits

A secured credit card is backed by savings account used as collateral on the credit available with the card. Money is deposited and held in the account backing the card. The limit will be based on both your previous credit history and the amount deposited in the account. This type of credit card is used by people with little to no credit or a past history of bad credit. The major benefit that these cards provide is the ability to rebuild or establish a credit history which at some point may allow users to gain unsecured credit cards or other forms of credit finance.
                         

Don’t think that a secured credit card and a prepaid debit card are the same as both have different characteristics. Prepaid debit card, where the cash collateral is placed into an account and drawn down by using the card. On the contrary, when you open a secured credit card, you are granted a line of credit with a zero balance and a predetermined credit limit. You are charged interest on the balance to your account.

Financial institutions or lenders may be unwilling to accept the risk of providing an unsecured credit card to a customer, so they instead offer a line of credit that has been secured with cash collateral. Secured credit card payments and balances are reported to credit bureaus. In fact, the information reported on your secured credit card is treated the same as any other credit card.

Here are some rules; you need to follow to build your credit.

• Wisely use your card

Use your card prominently as by simply having a new credit limit does not help out your score much. Instead, buy a few things each month and make your payments. Manage your card responsibly and you may see an increased limit or even qualify for an unsecured card in the future.

• Repay your balances timely

Try to pay off your balance consistently every month to have favourable results on your credit report, and you may even be able to avoid interest charges altogether if you make the most of any grace periods.

• Avoid using your card to maximum limit

If you max out on your card, you will incur higher interest charges on higher balances, but you hurt your credit utilization rate by borrowing too high a percentage of your limit.
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Source: Secondary

Check the categories and know debt for better benefits

At one point in our lives, many of us switch to debt as a method for making large purchases that we usually could not afford under normal circumstances. While encountering debt, you should know that there are several forms of debt: revolving debt, unsecured debt, secured debt and mortgages. It’s essential for you to review each category of debt thoroughly as not all debts are created equally and therefore some are considered to yield better benefits than others.

Revolving Debt

Revolving debt is an agreement made between a bank and customer that guarantees a maximum amount that can be loaned to the customer. Along with the commitment fee there are also interest expenses for corporate borrowers and carry forward charges for consumer accounts.  It is usually used for operating purposes, fluctuating each month depending on the customer’s current cash flow needs. Revolving debt can be unsecured, as in the instance of a credit card, or secured, such as on a home equity line of credit.

A line of credit and credit card are examples of revolving debt.

Secured Debt

Assets backing debt are considered security, which means they can be claimed by the lender if default occurs. A credit check is necessary for the bank to judge how responsibly you handle debt, but if you default on repayment, the bank seizes your assets, sells it and uses the proceeds to pay back the debt.

For instance, if you require a loan to purchase a car, the lender supplies you with the cash necessary to purchase it but also places a lien, or claim of ownership, on the vehicle’s title. In the event you fail to make payments to the lender, it can repossess the car and sell it to recoup the funds.

Unsecured Debt

This debt is not backed by an underlying asset. When a bank makes a loan with no asset held as collateral, it does so only on the faith in your ability and promise to repay the loan. It presents a high risk for lenders since they may have to sue to get the money they’re owed if the borrower doesn’t repay the full amount owed. As a result of this high risk, unsecured debt tends to come with a high interest rate.

Some instances of unsecured debt includes credit card debt, medical bills, utility bills and any other type of loan or credit that was extended without a collateral requirement.

Mortgages

Mortgages are the most popular form of debt and largest debt that many consumers confront in their lives. Mortgages are used by individuals and businesses to make large real estate purchases without paying the entire value of the purchase up front. Over a period of many years, the borrower repays the loan, plus interest, until he/she eventually owns the property free and clear. It typically carries the lowest interest rate of any consumer loan product, and the interest is tax deductible for those who itemize their taxes.
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Source: Secondary

Is Your Home a Collateral for Other Loans?

Collateral means to pledge an asset as a security against repayment of a loan. A collateral can be forfeited if there is a default on the loan. When you take Home Loan, you pledge your Home as a collateral for repayment of a Home Loan. But what if bank say that besides Home Loan, you have to give your Home as a collateral for any other loan or borrowing from the bank. On top of it, you also provide the commitment that this clause will cover all the past, present or any future borrowings from the Bank. Sounds Scary !!! But it is TRUE. Knowingly or Unknowingly, whenever you avail Home Loan, under Home Loan Agreement you also agree to clause “Indebtedness of the Borrower“. This is also known as Cross Collateralisation. By agreeing to this cause, you give your Home as a collateral for other loans or borrowings from the bank. Not all Home Loan Providers include this clause, but experts observed this clause in Home Loan Agreement of most of the Banks.

Ref to the sample copy of Home Loan Agreement of an Indian bank available online. Refer Article 1, clause 1.1, sub-clause “m” on page no 4. The definition is as follows

“Indebtedness of the Borrower” means any indebtedness of the Borrower to the Bank at any time for and in respect of monies borrowed, contracted or raised (whether or not for cash consideration) or liabilities contracted by whatever means (including under guarantees, indemnities, acceptance, bond, credits, deposits, hire purchase and leasing by the Borrower or by a person or entity related to or connected with the Borrower); and shall also be deemed to include any indebtedness of any associate or affiliate of the Borrower or any entity related to or connected with the Borrower, towards the Bank or any associates or affiliates of the Bank.”

To understand, let’s take an example of one lady. Her husband expired 4 years ago which put the entire family into financial problem. She was serving Home Loan from her salary. For her daughter’s education, she took the personal loan from the bank. Her Home Loan provider “Bank” happily approved the personal loan without any hassles. As her Mother in law is Class I legal heir of her husband’s wealth therefore under family settlement it was decided to sell the house. The proceeds will be divided equally between her and her Mother in Law. Recently, she closed the Home Loan but to her surprise Bank refused to issue NOC against Home Loan. Without NOC, she cannot sell the property. Bank put a condition to clear Personal Loan before they issue NOC for Home Loan. In short, Bank revoked Indebtedness of the Borrower clause in the Home Loan Agreement. In laymen terms, besides home loan her home is also a collateral for Personal Loan without her knowledge. Legally, the Home Loan Agreement is signed by her therefore she cannot claim ignorance.

Implications of Home as Collateral for Other Loans:

1. Indebtedness of the Borrower usually covers all loans/borrowing of a borrower i.e. Past, Present & Future from the bank.

2. Your Home will be collateral till you clear all the balance outstanding against all the loans with the banks.

3. The bank may include the clause to cover its associates, affiliates or subsidiaries under this clause. What it implies is that suppose you availed Home Loan from Bank A. Now, you availed Consumer Loan from ABC Finance Limited. ABC Finance Limited is a subsidiary of Bank A. In this case, your Home will also act as a collateral for your Consumer Loan.

4. Though you are securing your unsecured loans like Personal Loan, Consumer Loan etc by giving your Home as a Collateral. Unfortunately, you are paying higher interest rate for unsecured Loans. Normally loans which are backed by collateral are secured loans and charged at lower Interest Rate.

5. Bank reserve right to set off any amount against other borrowings without any intimation and consent of the borrower. For example, person defaulted on the credit card in past. It was reflecting in his CIBIL score also. Both credit card and Home Loan was availed from the same bank. Now the bank was smart enough and adjusted few Home Loan Installments against the credit card default. Normally, the borrower doesn’t check Home Loan statement but while going through some other details. As the balance outstanding against credit card was cleared willingly or unwillingly him. When we requested to update the same in CIBIL. Bank replied that since the account is closed therefore Bank cannot update the same in CIBIL. On raising the dispute, Bank referred the relevant clause in Home Loan Agreement.

6. Bank also reserves the right to encash PDC’s (Post Dated Cheques) deposited for availing Home Loan for other loans with the bank.

In short, by availing Home Loan from the bank you are giving your Home as security or collateral for all the Borrowings/Cross Default. All the amounts due to the bank or its affiliates/associates/Subsidiary will be due under Home Loan Agreement. It will be backed by Home as a collateral.

How to Safeguard your Financial Interests?

Though Home Loan agreement is standard format and bank will not exclude clause related to Indebtedness of the Borrower for one borrower. It is important to follow these points to safeguard your financial interests.

1. Read the Home Loan Agreement Carefully: You should read the document before signing. If you don’t understand certain clauses then it is always advisable to take professional help. In case, you have any apprehensions about the clause related to Indebtedness of the Borrower i.e. giving your Home as collateral for other loans then check other options. Before you apply for Home Loan, you should ask for a sample copy of Home Loan Agreement. If you will back out at later stage then it may impact your CIBIL Score.

2. Selection of Home Loan Provider: You should select your Home Loan provider carefully. Even if you have agreed to the inclusion of Indebtedness of the Borrower clause then you should ensure that you don’t have any existing financial relationship with the bank. In future also you should not avail any financial products especially loans, credit card, overdraft etc from the same bank.

3. Check your Statements Regularly: Many people have a habit of not going through the monthly/quarterly statements, but it is important to check them as and when you will receive. For any suspicious transaction, you should immediately bring to the notice of the bank.
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Source: Secondary

Are home loans new risk area for banks?

Banks are getting more careful in disbursing home loans – picking people with higher credit scores, for example – as property prices rise to unsustainable levels.

“Banks have become prudent and are looking at improving the health of their portfolio,” said Arun Thukral, managing director, Credit Information Bureau (India) Ltd, or Cibil.

“Who they lend to has also seen a major shift,” he said. “Earlier, they were lending to a person with a Cibil credit score of 600-700 to buy a house. Today, 60% of the home loans are given to people who have a score of at least 800.”

Indians are getting more leveraged than they were a decade back as salary increases have not kept pace with spike in home prices, burdening them with larger monthly loan payments. Experts fear that a more leveraged consumer, coupled with inflated home prices, can pose a risk to banks’ balance sheets.

Home prices in the metros have doubled in the last five years despite an economic downturn, according to data released by the National Housing Bank.

“The business is therefore prone to asset quality pressures, particularly if collateral values of the two most popular products – residential mortgage and gold loans – were to fall significantly,” said Ananda Bhoumik, analyst, India Ratings & Research.

Indian banks have changed gears in recent past, sharpening focus on retail loans as credit off-take on the corporate side remains subdued and uncertain. As such, consumer loans are considered a safer option as corporate bad loans soar in the sluggish economy. But there’s no undermining the risk here, too.

“Banks will have to recognise that retail credit comes with its own risks, exposing them to individuals in large volumes as against one corporate loan. The whole appraisal process and risk underwriting process has to recognise that,” said Satish Mehta, co-founder and director at Credexpert, a credit counselling company.

Though the mortgage-to-gross domestic product ratio remains low at 7% in India, most of the loan amount is skewed towards urban India. While no one expects property or gold prices to come crashing down any time soon, credit bureaus recognise the systemic risk.

“If the price of the collateral falls, then the risk that banks are carrying definitely goes up,” said Mohan Jayaraman, managing director at Experian Credit Information Company of India Pvt Ltd. “Due to this, many mortgage lenders are also getting into the theme of saying that they will do smaller ticket lending and the whole affordable housing thing is being taken more seriously now.”

Source: Secondary

Bank analyzes your credit worthiness this way

Credit risk analysis is an integral part of how banks lend money. It is a highly standardized process that tries to assess the desirability of an account by estimating the profitability and reliability of that account. Credit investigations are conducted by the banks to minimize the possibilities of experiencing loss from delinquent and late payments.

Understanding these metrics and processes that these banks use can help you in developing an approach wherein you can maximize your credit worthiness and access financing and business credit rating more effectively. So, how is this credit risk measured? Let us see below:

Credit Risk Analysis Metrics

• Reliability —
The measures of reliability used by the banks are references from past and current suppliers, owners or management’s qualitative character and credit payment history.

• Ability to Pay —
The applicant needs to demonstrate through business plans and financial models that he can generate consistent cash flows and enough revenue and that he is capable to make payments within the terms. This will also give the evidence that the business has been running for a certain time and will continue to operate successfully and keep paying its bills on time.

• Economic Conditions —
Industry and economic trends contribute to the bank’s assessments of risks and helps as an overall predictor of a business’s ability to maintain itself and recover its potentialities. If the industry is expanding rapidly, a successful credit arrangement goes on; conversely, the bank may be on more on the side of caution while considering a credit application, when the industry is shrinking.

• Collateral —
The most critical consideration in credit risk analysis is whether there is willingness by the borrower to back the desired loan or credit terms with an asset(s). If the bank is assured recourse to recover the losses via liquidation of the property of the applicant, then it is likely to feel secure in such an arrangement. In difficult financial situation, secured loans and loans are much more common.

How Does Credit Risk Analysis Inform Lending Practices
Each metric’s importance can vary greatly from one applicant to another. Not only do these metrics help the lender whether to issue credit report or not, but they also influence the credit limit, payment terms and other additional assurances.

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Source: Secondary

Factors on which lenders decide to give you loan.

After you apply for a loan, lenders estimate your credit risk based on a number of factors, like your income, financial situation and credit/payment history. These factors also known as ‘5Cs’ are explained below:

Credit history:
Qualifying for any type of credit largely depends on your credit history- which is the line of credit you've made by making timely payments and managing your credit efficiently. Your credit report consists of your credit history based on the information provided by creditors who have extended credit to you at a point of time. While one credit reporting agency’s information may vary from the other, all of them usually have the same information i.e the types of credit, payment history, lender’s names who have extended credit to you and more.

The lenders may also use the credit score given in the credit report. It serves as an indicator for the creditors about the credit risk involved. Usually higher the credit score, lower is the risk.

Capital:
Household income is expected to be the primary source of repayment in the cases of loans but in the cases where the person loses the job or experiences setbacks, capital helps repay these loans. Capital is the investments, savings and other assets which can help in repaying the loan. Thus capital plays a factor in the lending decisions too.

Capacity:
Creditors need to ascertain whether you can manage your payments comfortably or not. Your employment history and past incomes are a good way to determine your ability to pay off outstanding debts. Type of income, stability and amount of income can be considered. Debt-to-income ratio (DTI) which is the ratio of your current and new debt, as compared to your before-tax income, can be evaluated.

Conditions: 
Your plannnig of how to use the money also forms a part of the lender’s decisions. The loan’s purpose on whether it is for purchasing property or a vehicle is considered. Other than purpose, economic and environmental conditions are also considered sometimes.

Collateral (secured loans):
Credit cards, lines of credit or loans can be secured or unsecured. In secured, like a home or an auto loan, something you own has to be pledged as collateral. Value of the collateral will be evaluated, and past debts already secured by that collateral has to be subtracted from its value. The remaining value will play a part in the lending decision.

 The 5C's is a common term used in banking. Knowing these 5C's would help you better in answering questions the next time you apply for loan.

Source: Secondary

Character And Capacity in credit sphere !

Being credit healthy is the state of being in the pink of health – not your physical or mental health but your credit health. 

While measuring your credit score is a complex process as a lot of qualitative and quantitative factors come into play, there are also a lot of C’s that also plays an important role while presenting your credit report card. 

These five crucial C’s are – Character, Capital, Capacity, Collateral and Conditions. Of these, the first two are of high significance.  Credit bureaus are bang on when it comes to collating your credit scores depending on these C’s alone. 

Let us turn our focus to the two main qualitative prospects – Character and Capacity:

Character:

Character specifically refers to the reputation of the individual in accordance to his previous records while dealing with financial institutions. The credit history will divulge enough information that will indicate whether the individual is responsible is dealing with his finances or not. 

Instances of regular repayment of loans, credit cards and other bills indicate that the person is responsible with his money and understands the importance of timely repayment. Hence, he can come out as an honest and reliable person to repay a debt. 

On the other hand, if he lapses on paying his EMIs or is sporadic on paying his bills or is on the verge of bankruptcy, he is definitely tagged as irresponsible in his credit report. Such a person has a very high chance of missing out on the benefits of a good credit score like lower interest rates on loans, easier and faster approval on loans and credit cards, telephone connection, job prospects, insurance premia, rentals and a lot more. 

Therefore, you can see that the credit score is surely influenced by debt collection, bankruptcies, a high debt-to-income ratio, foreclosures and tax liens.

Capacity:

The second important factor is capacity of the individual. Capacity measures a borrower's ability to repay a loan by comparing income against recurring debts. In simple terms, the lender will want to know if you have valuable assets such as real estate, personal property, investments, or savings with which to repay the debt if income is becoming inadequate. This is because a large contribution by the borrower will reduce the chance of defaulting. Lenders look at the potential options that can be seized or taken away in case the borrower is not able to repay the loan. However, collecting of these assets is the last resort taken up by the lender.  

Now that you are aware of the two main criteria, let us quickly run through the other three - Capacity, Collateral and Conditions. Capacity refers to the individual’s ability to repay the debt and the lender will examine his/ hers current salary, living expenses, current debts and any dependents that the person might have. 

Collateral, on the other hand, is the asset that the borrower uses as a security for his the loan that he is applying for like property or a house. In case the borrower is unable to repay the loan, the lender can liquidate the collateral to pay off the remaining balance. Condition broadly means the present economic situation and how it is going to affect the borrower’s source of income. 

As you have become aware of the qualitative aspect of the way your credit is calculated, you can find out how this impacts on the quantitative side of it. Credit score is a numerical expression based on points system ranging from 300 to 900 points. 

If you manage to score between 700 to 900 points then it is a high scoring credit report. And if you find that you are lacking somehow and your credit score is not up to the mark, just avail the services of a reliable credit improvement company. 

Be credit healthy by opting service packages to raise your score at www.cibilconsultants.com

Source: Secondary