I will give you Rs 1 lacs. You have to pay me 5% interest. Sounds like a good deal?
I will add a few caveats.
- You must pay 5% interest upfront.
- Pay off the loan in 3 equal monthly installments of Rs 33,333 each.
Is this a joke? No, it is not. This is the revenue model of a fintech startup specializing in medical loans. I found out about this model in an excellent newsletter Ka-Ching from The Ken.
Yes, I understand you would reach out to a fintech company for a medical loan only when you have been denied by your bank and have exhausted other prominent formal funding channels. Medical loans are quite risky too, especially if you are taking out a loan for your own treatment. No one is sure how you will come out on the other side of the treatment. Thus, any lender must be compensated for the risk taken. However, what I shared above, the fintech model is convoluted and designed to mislead.
And that’s how borrowers can be played. And this is where a recent circular by The Reserve Bank is so critical. In the circular on Key Facts Statement dated April 15, 2024, the RBI has mandated the banks/NBFCs to disclose the Annual Percentage Rate (APR) for the loan. Note that the loan will not be provided by the fintech company but by the partner NBFC. Hence, it is the responsibility of the fintech company to disclose APR in the Key Facts Statement.
How Much Would This Medical Loan Cost?
Clearly, more than 5% p.a. Because 5% would be for the whole year. Here, the loan is only for a quarter. Hence, the effective cost of the loan is easily north of 20% p.a.
In a regular reducing balance loan, you pay off the interest cost with each installment. Here, the fintech company asks you to pay off the interest upfront, effectively reducing your loan amount.
Month 0: Inflow: Rs 1 lac – Rs, 5000 = Rs 95,000
Month 1: Outflow: Rs 33,333
Month 2: Outflow: Rs 33,333
Month 3: Outflow: Rs 33,333
This is an APR of 31.30% p.a. Nowhere close to 5% p.a. (which was the impression given). This is closer to credit card debt. Much expensive than a personal loan.
Is 31.30% p.a. Medical Loan a Problem?
It is certainly not cheap. But you are going here because you have already exhausted all options. Moreover, as discussed, medical loans are risky. If you don’t have any other options, you can’t be a chooser. You are a price-taker.
Plus, remember this is a short term loan. Interest cost does not hurt you as much. For all the discussion we had, you are paying merely 5,000 extra for a Rs 1 lac loan. A loan that you desperately need.
I understand an upfront payment gives at least some indication about your repayment ability and will provide comfort to the lender. I also don’t want to judge whether 31.30% is an appropriate rate of interest to charge for a medical loan. That’s between the borrower and the lender.
However, I would have preferred if the entire approach to recovering cost and interest was a bit more transparent.