BORROWING
How to Compare Loan Offers Properly
The interest rate is the number lenders compete on, so it is the number they make look best. A fair comparison puts every offer on the same footing and adds back the costs the rate leaves out.
Start with the total cost, not the EMI
An EMI tells you what leaves your account each month. It says nothing about what the loan costs. Two offers can have almost the same EMI and very different totals, and the easiest way for a lender to make a loan look affordable is to stretch it over more months.
The figure that tells you which loan is cheaper is everything you repay, minus the amount you borrowed, plus every fee you paid to get the loan. The rest of this guide is about getting to that figure honestly.
Put every offer on the same tenure
Lenders quote different tenures, and tenure moves the total cost more than most rate differences do. Take ₹5 lakh at 11%. Over three years the EMI is ₹16,369 and the interest comes to ₹89,297. Over five years the EMI drops to ₹10,871, which feels easier, but the interest rises to ₹1,52,273.
So before comparing rates, ask each lender to quote the same tenure, and choose the shortest one whose EMI you can carry comfortably. If an offer only works at a longer tenure, that tells you something too: the loan is larger than your budget easily allows.
Add the fees back in
Processing fees, documentation charges and the GST on them are paid once, usually taken out of the amount you receive. They never show up in the EMI, which is why they get overlooked. They still cost money, and on a short loan they can outweigh a difference in rate.
Here are two offers for the same ₹5 lakh over five years:
- Offer A charges 11% with a 2% processing fee, which is ₹10,000. The EMI is ₹10,871 and the interest over five years is ₹1,52,273, so the loan costs ₹1,62,273 in all.
- Offer B charges 11.5% with a flat fee of ₹999. The EMI is ₹10,996 and the interest is ₹1,59,778, so the loan costs ₹1,60,777.
The offer with the higher rate is about ₹1,500 cheaper. The gap is small here, but it runs the opposite way to what the headline rate suggests, and it widens as the fee grows or the loan gets shorter.
Use the APR when you can get it
The fairest single number is the annual percentage rate, or APR. It folds the fees into the rate by working out what you pay on the money that reaches your account. In the example, Offer A works out to an APR of about 12.55% and Offer B to about 12.22%, the same ranking the total cost gave.
Lenders in India have to give you a Key Fact Statement for retail loans, and it shows the APR. Ask for it before you sign, and compare APRs across offers with the same tenure. If a lender will not show one, work out the total cost yourself.
Read the prepayment terms
If there is any chance you will repay early, from a bonus, a sale or a better offer elsewhere, the prepayment terms matter as much as the rate. Lenders cannot charge a foreclosure or part-prepayment penalty on floating-rate loans taken by individuals for purposes other than business. Fixed-rate loans and many personal loans can carry one, often a percentage of the amount you repay.
A loan with a slightly higher rate and no prepayment charge can end up cheaper than a lower-rate loan that penalises you for clearing it. The loan prepayment calculator shows how much interest an early payment saves, which is also how much a penalty could eat into.
Check what is bundled in
Some offers arrive with insurance attached, most often a policy that clears the loan if the borrower dies. It may be sold as optional, or the premium may be added to the loan, in which case you pay interest on it as well. Neither is automatically bad, but the premium belongs in the cost comparison, and you can usually cover the same risk with a term policy you already hold.
Check too whether the rate is fixed or floating, which benchmark a floating rate follows and how often it resets. A floating rate that starts lower than a fixed offer can move above it within a year or two.
Compare in this order
- Ask every lender for the same loan amount and the same tenure.
- Write down the rate, every fee and any insurance premium for each offer.
- Work out the total cost, or compare the APRs from each Key Fact Statement.
- Read the prepayment and foreclosure terms, and the reset rules if the rate floats.
- Only then look at the EMI, to confirm that the cheapest offer fits your budget.
The same method works for switching a loan you already have. The balance transfer calculator sets the interest left on your current loan against a new offer after the cost of moving, which is the only saving that counts.
Know your limit before you shop
Lenders approve loans against their own ceiling, usually a share of your income that can go to EMIs. Being approved at that ceiling is not the same as being able to afford it. Work out the loan your income supports at a share you are comfortable with, using the loan eligibility calculator, and treat any offer above that figure as a warning rather than a compliment.
Your credit score also moves the rate you are offered. Check your credit report for mistakes before you apply, because every formal application is recorded as an enquiry, and several in a short time can count against you.