Difference between income and credit

Learn to manage your debt, otherwise debt will damage you

Every credit or a loan needs to be paid back. It is not to be treated as money earned or income. When we earn the money from salary or wages, etc, it is our income whereas credit or loan is not our income. On the other hand, repayment of the installments of credit is the expense.

When do we borrow?

We borrow money when our expenditure is more than our income or when there are emergencies. We also borrow when we need money for undertaking some business activities.

Should we borrow frequently?

Do not borrow for meeting consumption expenses like celebrating festivals, lavish wedding, buying jewellery or costly consumer durables.

If we have to spend money on these items, spend it from our income or accumulated savings. Use our current income or savings for consumption expenses. If we are forced by circumstances to borrow for consumption, first assess how much we can repay out of our current income. Consumption expenses do not give any income, then how will we repay the loan? On the other hand, we would be borrowing again and again from different sources for repaying earlier loans and would fall into the debt trap.

Borrow for income generating activities

It has to be kept in mind that when we take a loan, it has to be repaid back with the interest. So while borrowing, we should always assess our repaying capacity. When we borrow for undertaking some business activities it will enhance our income, then we can repay the loan out of income generated, e.g., when we borrow Rs. 1,000 from a bank to buy seeds, which will give us crop that can be sold for‚ Rs. 10,000, we can repay Rs. 1,000 + Rs. 100 as interest, i.e., Rs. 1,100 to the bank and the remaining amount of Rs. 8,900 is our additional income.

We should borrow for an activity which gives earnings more than the amount of interest payable, otherwise we may have to borrow again to repay earlier loans.

“Borrow for undertaking an activity which enhances your income.”

Why borrow within limits?

Any loan taken by us has to be repaid back with the interest. Make sure we are earning enough to pay back the loan. A simple way to check is look at our income, expenses and saving every month. The saving should be more than our monthly installment of repayment of loan.

Borrowing: Banks or moneylenders

Bank is a better source of finance than money lenders and other informal sources even if, at times, it may take little longer to borrow from them. It is a safe, reliable, transparent institution which can help us by lending money on suitable terms.

Banks are regulated by Reserve Bank of India. Best thing is that banks charge lesser interest than informal sources, viz., relatives, friends, moneylenders, vishi, mukhiya etc. Besides, banks create full documentation of the loan before disbursing loan amount. In case of dispute, Grievance Redressal Mechanism is also available.

“Banks are transparent and charge less interest.”

Grievance Redressal Mechanism of banks

Banks are regulated entities. Every bank has a grievance redressal officer, the details of which are published in all branches and also on their website. In case of any dispute, we can file our complaint with the grievance redressal officer of that bank. In case we are not satisfied with the resolution of the dispute by them, we can file our complaint with the Banking Ombudsman of the Reserve Bank of India.

There is no grievance redressal mechanism in case of informal sources as they are not regulated entities. That is why there is lack of transparency in the terms and conditions and also in the record of transactions in case of informal sources.

Banks may at times take little longer time in giving loans compared to money lenders. The banks collect deposits from public and lend this depositors’ money as loans to the people who need it. To protect the depositors’ money, they are expected to ensure the proper utilisation of the money by the borrower. Hence banks undertake detailed scrutiny of the loan proposals before sanctioning the loans. Though it may take a longer time, the benefit to the borrowers is that they cannot be cheated since everything is documented. It is actually in the interest of the depositors as well as the borrowers.

Loans offered by banks

Banks give loans for various purposes like housing, education, agriculture and related activities, starting a business enterprises, consumption loans, etc. Thus banks meet all types of loan requirements.

We have to submit a loan application to the bank indicating the purpose. The bank will verify the details, evaluate our repaying capacity and then sanction us the loan which we will have to repay along with the interest in installments as indicated by the bank.

Cost of borrowing from banks

The interest charged on the money borrowed is the cost of borrowing. Understand the interest cost we are paying on our loan. Banks normally notify the interest rate per year, e.g., annual interest of 12% means 1% interest per month. Frequency of compounding is also important in the price of a loan. Unlike other informal sources who do not tell us the real cost of borrowing, the interest rates and other charges levied by banks for various purposes are displayed to the public and it is uniform for all customers/purposes. Banks publicly declare how much they charge and they charge uniformly to similar customers for similar purposes again unlike other sources.

Do we have to offer some guarantee for the loan?

This depends upon the type and purpose of loan we take. Generally for small loans no guarantee will be necessary. But for higher amounts we will have to offer some guarantee. This can be in the form of the asset which we will be creating with our bank loan or in the form of other collateral securities like land, house etc., depending upon the type of loan.

What if we do not repay the loan taken from the bank?

In case we do not repay the loan, the bank will have the right to take possession of the security we have offered as guarantee for the loan and can initiate legal proceedings against us for recovering the loan amount along with the interest.

Source: Financial Literacy Guide, Reserve Bank of India

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