Term Loan Appraisal Against a Flat-Rate Dealer Quote
Sanjay, 38, runs a dairy-transport business in Ujjain and applies for a term loan to buy a refrigerated van with an on-road cost of ₹9.60 lakh. He declares net monthly income of ₹42,000; his six-month bank statement averages ₹38,000 a month. He already pays a car loan EMI of ₹6,500 with 34 instalments remaining. He asks for ₹8.00 lakh at 11.5% per annum on reducing balance for 60 months. Branch credit policy caps FOIR at 50% of assessed net monthly income and requires a 15% margin on the vehicle's on-road cost. A dealer has offered him the same van on hire-purchase at a "flat 9%" for five years, quoted at ₹19,333 per month, and Sanjay argues that the dealer is cheaper than the bank. The loan committee meets tomorrow and the branch manager needs a reasoned appraisal note, not an opinion.
1. Compute the EMI on the requested ₹8.00 lakh at the stated terms, the FOIR on both declared and assessed income, and the maximum loan the policy will support. Show the working.
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Step 1 - EMI at ₹8.00 lakh. r = 11.5/12/100 = 0.0095833; n = 60; (1+r)^60 = 1.7722. EMI = P × r × (1+r)^n / [(1+r)^n − 1] = 8,00,000 × 0.0095833 × 1.7722 / 0.7722 = ≈ ₹17,595 Total repayment = 17,595 × 60 = ₹10,55,700; interest = ₹2,55,700.
Step 2 - FOIR. Existing obligation ₹6,500 + proposed ₹17,595 = ₹24,095.
- On declared income: 24,095 / 42,000 = 57.4%
- On assessed income: 24,095 / 38,000 = 63.4% Both exceed the 50% cap. The 91-day-delay pattern in the statement is a separate negative.
Step 3 - maximum permissible loan (using assessed income, which is the conservative and therefore correct base). Permissible EMI = 50% × 38,000 = ₹19,000, less existing EMI ₹6,500 = ₹12,500. P = EMI × [1 − (1+r)^−n] / r; (1+r)^−60 = 0.5643, so the factor = 0.4357 / 0.0095833 = 45.468. P = 12,500 × 45.468 = ≈ ₹5,68,000. On declared income the figure would be ₹6,59,000 - the gap shows exactly why the assessed income must be used.
Step 4 - margin check. 15% margin on ₹9.60 lakh means the bank can fund at most ₹8.16 lakh, so the FOIR cap, not the margin, is the binding constraint. Sanction ≈ ₹5.65–5.68 lakh, and the reason for the shortfall must be stated in the sanction letter so the borrower is not left guessing.
2. Sanjay says the dealer's "flat 9%" is cheaper than the bank's 11.5%. Test that claim with numbers at the eligible loan amount and advise the committee.
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The comparison is being run on two different quantities. The dealer's ₹19,333 is the EMI on ₹8.00 lakh at flat 9%: interest = 8,00,000 × 0.09 × 5 = ₹3,60,000; total ₹11,60,000 ÷ 60 = ₹19,333. The bank is being asked to lend ₹8.00 lakh but will actually sanction about ₹5.68 lakh. Like must be compared with like.
At ₹5.68 lakh:
- Flat 9%: interest = 5,68,000 × 0.09 × 5 = ₹2,55,600; total ₹8,23,600; EMI = ₹13,727.
- Bank at 11.5% reducing: EMI = ₹12,500; total ₹7,50,000; interest ₹1,82,000.
- The dealer costs about ₹73,600 more over five years.
Why flat rates mislead. A flat rate is charged on the original principal for the whole tenure, although the principal is steadily repaid. Solving 13,727 / 5,68,000 = r(1+r)^60/[(1+r)^60 − 1] gives r ≈ 1.31% per month, i.e. about 15.7% per annum nominal on reducing balance, roughly 16.9% effective - well above the bank's 11.5%. As a rule of thumb, a flat rate must be multiplied by about 1.8–1.9 to approximate the reducing-balance rate.
Recommendation: record in the note that the bank's offer is cheaper on a comparable basis, sanction ₹5.68 lakh (not ₹8.00 lakh), and show the borrower both amortisation schedules. Telling him the truth about the shortfall now is better than a rejection at the counter later.
3. Beyond EMI arithmetic, what should the branch verify before recommending the proposal, and how should the shortfall be communicated?
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Verification checklist:
- Income quality. The van's earnings depend on trip volumes and diesel and driver costs; ask for trip sheets, dairy-plant contracts and a rough profit estimate, not just the bank statement. A 91-day average balance does not demonstrate a ₹42,000 sustainable surplus.
- Existing loan track. Repayment record on the car loan and the credit-information report; any overdue, write-off or settled account is a material fact.
- Vehicle economics. Invoice, on-road cost split, hypothecation in the bank's favour, insurance with the bank's clause, and RC endorsement. Confirm the dealer's quote applies to the same model and tenure.
- End-use control. Disbursement by direct payment to the dealer against the invoice, not to the borrower's account.
- Margin source. The 15% margin (₹1.44 lakh) must be the borrower's own funds and evidenced, not a borrowing from an informal lender.
Communicating the shortfall: issue a written sanction of ₹5.68 lakh at 11.5% reducing balance, stating the FOIR computation as the reason for the reduced amount, and give the borrower the option of a longer tenure or a co-applicant whose income can be clubbed - both are legitimate ways to restore eligibility, unlike inflating his declared income. Note in the file that the dealer's "flat 9%" was evaluated and found to be about 15.7% on a reducing-balance basis. If he declines, record the refusal; do not sanction ₹8.00 lakh and leave the committee to discover the FOIR breach later.