COVID-19 Crisis: The Loan Hierarchy

The nationwide lockdown to prevent the spread of Covid-19 has affected the cashflows or income potential of many citizens. While it is painful to imagine the plight of daily wage earners, many in the organized sector have also struggled. Every day you can hear about the salary cuts or employee layoffs. And this is coming from big stable companies. You won’t even hear such news about smaller companies.

I am sure, for many, the sword is constantly hanging over the head. Not a pleasant situation to be in. If you are in such a situation or fear that you can be in such a situation soon, what should you do?

#1 Emergency Fund

Your first line of defence is your contingency fund or an emergency fund. If you have a sufficient emergency fund of 6-8 months of expenses including EMIs, then you are fine. If you do not have such a buffer with you in bank fixed deposits or liquid funds, then you might want to focus your energy on accumulating the requisite emergency fund, especially if your employment prospects are circumspect (based on lockdown impact on your current employer or the industry where you work). You can consider stopping your long-term investments (SIPs etc) to accumulate a robust emergency fund first.

#2 Secured Loans against Liquid Assets

Subsequently, you can consider generating funds from your liquid assets. One of the simple ways is to take a secured loan against such assets as bank fixed deposits, gold, insurance policy, stocks or mutual fund units. You should be able to quickly raise funds using this route.

SECURED LOANS
  1. Loan Against Bank FD
  2. Gold Loan
  3. Loan Against Securities (stocks or mutual fund units)
  4. Loan Against LIC Policy
  5. Loan Against National Savings Certificates (NSC) / Kisan Vikas Patra (KVP)
  6. Loan Against Property

With secured loans against liquid assets, you must always consider the option of selling the investment rather than taking a loan against it. With your assets, the returns are not guaranteed while the loan interest must be paid. If your cashflow troubles are longer than temporary (and that can be the case when the issue is your employment), it is better to sell the asset rather than take a loan against it. Note that the answer will be different if you want to take a loan against property (LAP). That will likely be your last resort.

Taking a secured loan against a liquid asset can be useful only when the amount of loan is quite low as compared to value of the asset OR you have an emotional attachment with the asset.

Moreover, if you are worried about employment prospects, it is a good idea to gradually keep generating liquidity in the portfolio. For instance, if you have a big stock portfolio and you foresee employment and concomitant cashflow troubles, you can sell some stocks from the portfolio gradually.

By the way, the banks are coming out with interesting loan products. Recently, I read about a limited period gold loan product from Canara Bank, where the interest rate was 7.85% p.a. It is difficult to get a home loan at this rate. The maximum loan amount is Rs 20 lacs and the loan offer is open till June 30, 2020.

While I would still prefer to sell gold than take a loan against it, there might be reasons why a loan can be a good choice.  Firstly, you may have gold jewellery. Only the value of gold is considered at the time of sale. Secondly, you may have emotional attachment with gold. If you are planning to take a loan, do keep an eye on such products.

#3 Unsecured Personal Loans

Personal loans are more expensive than secured loans. Hence, you must consider this once you have exhausted your secured loan options. However, personal loans have quick disbursal times and require minimal and sometimes no paperwork. The lockdown or your unwillingness to travel to a bank branch or an NBFC branch can tilt the balance in favour of personal loan too. Do note, it is easy to get personal loans when you are still on job. Once out of job, it is difficult to get a personal loan.

For all the loans, secured or unsecured, you will still have to pay EMIs which may not be easy if you are out of job. Even to pay these EMIs, you need an emergency fund. These days, many banks are offering moratorium on payments (interest or both principal and interest) on fresh personal loans. You can consider such options.

If you want a longer rope, you can use a loan and your emergency fund together. Rather than waiting for the emergency fund to exhaust before you consider the sale of assets or loan against assets or personal loans, you can access emergency fund and loans at the same time. For instance, let’s say you have an emergency buffer of Rs 5 lacs. At Rs 50,000 per month of expenses, this money will last for about 10 months. If you take a personal loan of Rs 5 lacs for 24 months, you have a longer rope. Now, you have 10 lacs, which can last for about 15 months (consider EMI of Rs 16,000 per month). This is not a financially optimal solution. Remember there will be 21 EMIs still left to be paid. However, as mentioned earlier, this gives you a longer rope.

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