There is a proverb in English -“Look before you leap” that means think or consider the consequences before doing something important or making any important decision. Because sometimes things cannot be reverted, if anything happens adversely that may cause great losses. Borrowing from Bank or financial institution is also such an important decision for a prospective borrower. People borrow from bank for mitigating their scarcity. But to mitigate this need every borrower must consider some basic things before borrowing from the Bank or financial institutions. Borrowing without proper calculation and assessment may cause failure to repay the loan timely as a result the borrower may become defaulter which creates problems in personal life as well as social life, even he or she may loss his assets to compensate the Bank loan.
That’s why borrowers should plan carefully before taking loan from bank or financial institution. In this regard I have pointed out some considerable factors that the borrower may keep in mind before taking loan.
Borrowing limit: First of all, assess your financial need to complete your expected job. Then, calculate how much money or capital do you have and how much money is required as loan. In financial language this is called leverage. Combination of own capital and loan. The standard ratio is 1: 1. That means, if you need Tk.100 to complete a job then you may borrow highest Tk.50 from Bank. But the ratio may vary considering different requirement. But in thumb rule, your borrowing limit should not cross 50% of total requirement. It’s a foolish decision, if someone wants to complete the entire job by utilizing 100% or maximum bank loan. Utilising maximum amount by bank loan increase the cost of doing job and minimise profitability or efficiency of the work.
• Cost of the Bank Loan: Before taking loan, you must consider the rate of interest of the loan. Because for completing a job efficiently, rate of interest of loan is very important. If the loan is for personal purpose for purchasing any personal asset e.g. flat, car or home appliance etc., borrower must consider the rate of loan and duration of loan. If the duration of loan is longer, the lower will be the size of installment but higher the interest you have to pay to the bank. But, if the duration of the loan is shorter than the installment size will be relatively high but total interest payment i.e. cost will be low. In case of business loan, rate of interest is main factor for profitability. If the rate of interest of Bank loan is high then it adversely affect your profitability. Interest coverage ratio can be calculated to assess whether the interest is favourable considering to the income of a business concern. It can be calculated by dividing earnings before interest and tax (EBIT) by total interest. The higher the result, the more favourable will be present interest rate.
• Nature of Loan: Whether the loan will be short term (upto 1 year), mid term (2-5 year) or long term (more than 5 years), it should be considered on the basis of nature of investment/ requirement of the fund as well as repayment capacity. If the loan is required for acquiring a fixed or movable asset the nature of loan may be mid or long term. But, if the loan is for mitigating any sudden expenditure, then loan may be short or mid term. On the other hand, for working capital requirement of the business, the loan may be short term period. You may apply for moratorium period/ grace period in repayment schedule if you think that return from the invested project may be delayed for its nature or any other valid reasons. But, it must be kept in mind that the cost of loan increases due to moratorium/ grace period.
• Capacity and sources to return the loan: This is very important and most crucial issue in times of taking a loan. Self assessment is required for considering the own capability to repay the required loan. In case of any personal loan or any term loan which is repayable by fixed installment must be repaid from the fixed free hand income. Free hand income means the amount of income which remain after deducting all sorts of expenditure (family, personal and business), monthly savings installments (if any) and any unanticipated normal expenditure. It is very logical if anybody consider the present income level while assessing free hand income. Any future income, if not certain should not be considered in assessing free hand income. Besides, debt-burden ratio can be calculated to consider the further loan capability. Debt-Burden ratio is the percentage of all loan burden/ installment in compare to total income (All loan monthly installment/ total monthly income). If it is below 50%, it may be considered as capability to repay the loan. In case of continuous loan (specially taken by business man for mitigating working capital), borrower must consider the net income. Whether the business net income before paying interest and depreciation is sufficient to repay the loan (principle amount + interest). In financial language this is called debt service coverage ratio.
• Personal Net-worth: Personal Net-worth means total asset that remains after deducting all liabilities. While taking loan someone must consider the net-worth. Because, this will work as last resort, if someone fails to repay the loan from his regular income due to any unexpected reasons. If your net-worth is still good after taking the loan then you can easily repay the loan by redeeming any asset, if you fail to repay the loan normally. So, never borrow any money more than your total asset.
These are the factors that should be considered before taking loan but after taking loan one should go by the following rules for proper management of the loan:
• Never divert the fund elsewhere. The purpose you borrow the money must utilise the fund in that purpose. This will ensure to work the loan as per your projection. If you divert the fund elsewhere you may loss probable return from loan. Diversion of fund elsewhere is also a crime.
• Do not use short term loan for purchasing any fixed asset or in any project where return require longer period.
• Keep your commitment strong regarding repayment of loan. By all means, give priority to repay the loan first before making any other expenditure. Because, failing to repay the loan in timely manner will increase the cost of loan, decrease your goodwill as well as will create your bad credit history.
• If you feel in the life cycle of a loan that repayment of loan may be disrupted due to unexpected reason which is unavoidable, inform your bank and find out best alternative way out. Because there are option of loan restructuring or rescheduling or early settlement for any valid reasons.
Now a day, in Bangladesh the number f loan defaulters has increased alarmingly. But, not all the loan defaulters are habitual defaulters. Most of the loans are defaulted due to wrong decision prior to taking loan and lack of proper management of loan in its life cycle. If the borrowers become conscious regarding the loan, then the bad loan can be reduced significantly. For this, Bankers have to advocate the borrowers judiciously and borrower has to disclose all the facts and information to the bank while taking loan for the sake of their own interest.
The writer is a Banker