The six-month moratorium on loan and interest payment announced by the Reserve Bank of India in March due to the COVID-19 lockdown is set to end on August 31 unless the central bank or the central government has a change of heart at the last moment. Many borrowers have asked for the moratorium to be extended till December 31, 2020, but RBI and banks are dead against this.
This is sure to hit the finances and monthly budget of individuals who either lost jobs during the pandemic or saw a sharp drop in their income or faced salary cuts. The biggest blow would be for home loan customers, given the large sums involved, and those who bought expensive cars on loan.
So what are the options if you have a big loan to repay but lost the matching cash flow or income to service it?
1.If you have not done it by now then take a piece of paper and pencil and work out your income and expenses afresh. In our daily grind and impromptu expenses, we lose track of our cash inflows and outflows. Writing down all your expenses and cash flows in the last month will provide you with a correct picture of your financial position. This is important to plan the next move regarding loan servicing.
2. Now make an inventory of all the assets that you and your family own. This includes jewellery, financial assets such as fixed deposits, life insurance policies, mutual fund units, bonds or savings certificates if any, employee or public provident funds (EPF or PPF), new pension scheme, real estate assets such as house, land or commercial property and vehicles. Then put a fair market value to all these assets. Now net out the outstanding loan amount from their market value if any of these assets have been bought on loan.
For example if the fair value of your family assets works out to be Rs 50 lakh but the sum total of all pending loans on your auto and home loan is say Rs 30 lakh then, your total net worth is 20 lakh.
3. Now that you are fully aware of your cash flows and balance sheet, it’s time to have a hard look at assets or the thing that you bought on loan. What if the bank takes the possession of that car or that home? How will it change you and your family’s life? I know this is the worst case scenario but it will help you to come up with a plan B now that you are fully aware of your financial position. If the loan is against low-value home appliances such as television, air conditioner or refrigerators then you should not fret too much. Lenders will not be in a hurry to take their possession given the steep price depreciation in these items.
4. The government has appointed KV Kamath Committee to work out the details of a loan restructuring scheme for both businesses and individuals. Once the recommendations are out and accepted by the government and the RBI, this can be availed by the home loan customers.
If you have a home loan then you can take advantage of this to work out a loan restructuring plan with your bank or home loan company. Loan restructuring is a technical sounding word for stretching the loan repayment period that may include a grace period where you make no repayment or small payment followed by a large payment later on.
Here your worksheet on cash flows and balance sheet would prove critical to convince the bank about your repayment capacity in the longer term. Ask for a grace period of 6-12 months that gives you time to recover your earnings to service the loan. But remember it will increase your loan amount and the interest due on it. For an outstanding home loan of around Rs 30 lakh, a 12-months grace period would increase the principal amount by around Rs 3 lakh that will translate into higher EMIs once repayment resumes. Be prepared for that.
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5. There has been a decline in interest rates in the last three months including home and auto loans. Now that the moratorium is ending, you can talk to the loans officer to reduce the interest on your loan. This is called loan conversion in industry parlance and banks are more than happy to do it in exchange for a conversion charge. The charges depend on the loan amount but it works out to be around Rs 200-300 per lakh. You can choose to either reduce your EMI or monthly outgo or reduce the EMI tenure or a mix of both. See what your finances allow.
6. Lastly if you have financial assets such as bank or post fixed deposits or mutual fund units, it’s recommended that you redeem them and use it to prepay a part of your home loan. There has been a sharp decline in interest rate on FDs in the last few months and they are much lower than the interest on home loan. You lose money by keeping, say, a Rs 5 lakh worth FD at a bank that earns 5.5 per cent and paying 7.5 per cent on a home loan. Break the FD, prepay the loan and reduce your EMI.
The same logic applies to equity mutual funds given the record high stock valuations that greatly reduces the upside potential from the current levels. These are unprecedented times. By managing our finances better, we can definitely reduce the pain.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).