I keep telling people – the problem with borrowing is NOT the loan, it is the interest. And the inflation that we cause by borrowing, and repaying – we are creating money, are we not?

Let us say you borrowed Rs. 20,000 to buy a house and it is a 30 year loan. Clearly you would have repaid 72,000 + processing fees+risk premium on your life, on the property…etc. Which means you have paid about 52000 as interest for a Rs. 20,000 loan. Great.

Did the bank ‘give’ you this money by pulling out 20k from its vault? Hey no. They just pressed a few buttons. Sure they had to process the application, keep records, etc. BUT they did not produce ANYTHING to claim such a huge compensation. And I am not even talking of the fact that the bank would have earned much much more because this 52k came on a monthly basis and it was being used during the 30 year period.

What did this extra 520k do for the economy? Nothing really. It went to pay some interest to somebody in the bank, salaries, rent, mistakes of the bank, etc. – LARGELY IT CONTRIBUTED TO INFLATION because it was money for which NOTHING else was done!

This combination of ‘repaying’ what was not there and the ‘interest’ on something which did not exist goes and crates an unending supply of money. Unending supply does the worst thing that it can do – fuels inflation.

There is another bad effect of interest – it slows down the speed at which money gets circulated. For example if you borrowed Rs. 20,000 and repaid Rs. 200 per month you should have finished the repayment in 8 years. However because you paid an extra 520k you are paying this over a 360 month period!! So interest slows down the money circulation – thus increasing the need for money. So more money has to be printed. Eeks this mean more inflation, right?

Inflation also encourages HOARDING. If I can postpone my payments I will – because my rupee of tomorrow is worth less than rupee of today. Funnily interest payments encourage hoarding, and delaying of payments. This might lead to a higher NOMINAL payment but a lesser REAL payment. Oops. Tough to understand is it?

 

 

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  1. Tough to understand is it?

    –sir what sir, it is waste paying rent sir, instead of that i pay emi every month sir i own the house (ahem) and save tax also sir!

  2. ubra, taking a loan (if you do not have the money) to buy an asset is generally a good idea. My understanding is that Tata, Reliance, Birlas do take loans to run their business or to buy or build assets. In this case the asset happens to be a house.

    Even Warren Buffet had take a loan to buy a beach house near LA.

    I am not sure why you are discouraging taking of loans.

  3. Sir,
    if one take a home loan for 200k and the property price increase in the same pace and to add to this you are saving tax and paying no rent then its a worth taking a loan.

    Your input…

  4. It goes further. People keep unproductive assets like gold and opt to take loans and pay interest instead. Just think about it for a minute.

    I always advise people to sell off their gold to pay off their loans as soon as possible. So far, not even one person has heeded to my advise.

    Of course, housing finance stocks are a substantial part of my portfolio now. 😀

  5. Thanks for a Nice Article on Interest and Inflation. Really a master piece.

    I was wondering why India alone has more than 12% inflation when there is less inflation (single digit or even deflation) in other countries like US, UK and Japan.

    Some where i read that a US Citizen can get loans at 1-2 % and invest safely in India (Stock Market or Debt Funds) and earn a decent returns.

  6. @Prashanth : Tata, Reliance, Birlas take loans to build businesses and get income which will be multiple times of the loan amount. Does our homes give income like that (except rent) ?.

    My Opinion will be if for Business where you cannot go to stock market to raise money, get loan from Banks.

    If for personal consumption like Home etc, try to avoid loan or take as little loan as possible (If my memory is correct, Subra Sir has suggested us to take only 50% of money required to buy the house – rest should come from our own funds) and make it a point to close the housing loan as early as possible (by taking a higher paying job or doing more business etc).

  7. Subra Sir,

    Just think of people who have used Credit Cards or Personal Loans for buying Gold Jewels during “Akshaya Tritiya” each year.

    At least in Tamil Nadu, “Akshaya Tritiya” concept for spread by Jewellery Shops for last 3-5 years only. Before that there was no “Akshaya Tritiya”.

    I read in newspapers that around 2500 KG of Gold was sold in Tamil Nadu alone!. Out of that at least 50 % would be using Loans / Credit Credit Cards.

    Seems like one should start researching stocks of some Good Gold Loan / Finance Companies or Banks to buy. 😉

  8. Sir,

    If higher interest rates lead to higher inflation why does the central bank not reduce interest rates to curb inflation ?

    From what I understand, interest rates are only lowered once inflation numbers are lower for a sustained period.how does this make sense?why not lower interest rates first and which will lead to lower inflation..

  9. Sir,
    what I understand is to pay loan for full tenure and extra money got as bonus or wages hike ( 🙁 ) to be invested in other instrument….like MF and stocks…

  10. Hello Sir,

    I have confusion on following statement:

    There is another bad effect of interest – it slows down the speed at which money gets circulated.

    How it would slow down circulation of Money. Banks give Home Loan to consumer. But, that is given to Builders indirectly. And from Builders it will be circulated further.

  11. Housing loan interest is about 10%. After tax rebate, it comes to around 7%.

    Rent is about 2-3%. Let’s say 3%. If appreciation is expected to be 4% per year, then total return is 7%. If it is more than that, then it is worthwhile to take a loan. If not, do not invest in that house.

    In most cases, house value keeps up with inflation, the rent bumps it up a little above inflation, providing real return.

  12. I know a colleague is trying to sell a new ready-possession 3 BHK in ghodbunder for 1.2Cr, but no genuine buyers for last 1 year. Max rent he can get is 18-20K per month. There are hundreds of such flats in his complex and nearby area, all lying vacant. Builders quote upwards of 1.4Cr for similar *under-construction* flats! Is this trouble or what?

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