The term consumer finance and consumer credit are used interchangeably in the common parlance. It refers to the raising of finance by individuals for meeting their personal expenditure or for the acquisition of durable consumer goods and for the purchase creation of an asset. In a typical consumer finance transaction, the individual consumer buyer pays a fraction of the purchase price in cash at the time of the delivery of the asset and pays the balance with interest over a pre-determined period of time. Consumer finance is emerging as an important asset-based financial service in India with the objective of providing finance on easy terms and at the door steps of the consumer. Various banks, both public and private, and finance companies are in the field to provide such service. They help the consumers in obtaining necessary finance for the purchase of not only the consumer goods such as TVs, refrigerators, washing machines, personal computers (PCs), cooking ranges but also for the construction purchase/renovation of a house, education in India and abroad, and for the purchase of cars/scooter etc. Finance is generally extended for a period of two to five years.
At present, there is no specific legal framework provided by any legislation to regulate consumer finance transactions in India. Various important aspects of consumer finance include:
1. Parties to the transaction
2. Modes of consumer finance credit
3. Procedure for granting finance credit
4. Terms of financing/credit
5. Purpose of raising finance
6. Benefits of consumer finance
Types of consumer loan
The term consumer financing service refers to the activities involved in granting credit to consumers to enable them possess own goods meant for everyday use. It is known by several names such as credit merchandising, deferred payments, installment buying, hire purchase, pay-out-of income scheme, pay-as-you earn scheme, easy payment, credit buying, instalment credit plan, etc.
There are several types of credit facility available to consumers. They are briefly discused below:
(1) Revolving Credit : An on-going credit arrangement similar to a bank overdraft,whereby the financier, on a revolving basis, grants credit, is called 'revolving credit'. The consumer is entitled to avail credit to the extent sanctioned as the credit limit. An ideal example of revolving credit is credit cards.
(2) Fixed Credit : It is like a term loan whereby the financier provides loan for a fixed period of time. The credit has to be squared off within a stipulated period. Examples of fixed credit include monthly installment loan, hire purchase, etc.
(3) Cash Loan : Under this type of credit, banks and financial institutions provide with which the consumers buy articles for personal consumption. Here, the lender and the seller are different. The lender does not have the responsibilities of a seller.
(4) Secured Finance : When the credit granted by a financial institution is secured by a collateral, it takes the form of secured finance'. The collateral is taken by the creditor in order to satisfy the debt in the event of default by the borrower. The collateral may be in the form of personal property, real property or liquid assets.
(5) Installment loans : These loans are those that are paid off during a set timetable, usually monthly. During each payment period, a portion of interest and principal is paid off.Every new month pays more and more of the principal amount off. Most likely a loan on your house or car is your standard instalment loan.
(6) Single-payment loans : These terms are short term loans (usually under a year) that are usually referred to as Balloon loans. They can also be known as Bridge Loans. Usually these balances are paid off all during one period hence the balloon payment. Many times these are used as a temporary loan until better financing can be found.
(7) Unsecured loans : These are loans that do not require any collateral. These loans are usually reserved for those with a special expertise or with a high credit score. As a result, interest rates for unsecured loans can be very, very high.
(8) Convertible loans : These loans incorporate the changing of the structure of the interest rate type. For example you may have the first five years with a fixed interest rate, with the last five years changing to a variable interest rate, or vice-versa.
(9) Variable-rate loans : These are loans in which the interest rates are subject to move based on a moving index that the loan uses as a benchmark, such as prime or the Treasury Bill. These usually have caps or ceilings on how high they can move in a given period. The rate can change multiple times during the year.
Most people will eventually resort to a consumer loan as it can be a vehicle to buy things of bigger value. However, these should be used with caution and with a lot of tough process.
Sources of consumer loan
The various sources of consumer finance available to people are discussed below
(1) Traders : The predominant agencies that involved in the provisions of consumer finance are traders. They include sales finance companies, hire purchase and others financial (non-bank) institutions
(2) Commercial Banks : Commercial banks take keen interest in providing directly or indirectly, the finance for consumer durables Banks lend large sums of money at wholesale rates to commercial or sales finance companies, hire purchaseconcems and other such financial intermediaries. Recently, banks have also started directly financing consumen through personal loans, which are meant for purchasing consumer durable goods. Personal loans are granted without a security. They are cheaper than hire purchase credit
(3) Credit Card Institutions : Credit card institutions arrange for credit purchase ofconsumer articles through the respective banks which issue the credit cards. The credit card system enables a person to buy goods and services on credit. The credit card scheme operates in the following way:
On presentation of the credit card by the buyer, the seller prepares three copies of the sales voucher-the first for the seller, the second for the bank or Credit Card Company and the third for the buyer. The seller gives one copy to the buyer and the other is forwarded to the bank for collection. The seller's bank forwards all such bills to the card issuing bank or company. The bank credits the seller's account and debits the amount to the customer's account. The buyer receives a monthly statement from the card issuing bank or company and the outstanding amount is to be paid within a period of 45 days a without any additional charge. If payment is delayed, bank charges interest per year on the amount outstanding.
(4) NBCS : Non-banking finance companies constitute another important source of consumer finance. Consumer finance companies, also known as small loan companies, personal companies or licensed lenders, are non-savings institutions whose prime assets constitute sale-finance receivables, personal cash loans to consumers, short and intermediate- term business receivables, etc. These finance companies charge substantially higher rates of interest than the market rates. Consumers approach them as a last resort. Such companies run an equal risk of high collection charges too.
(5) Credit Unions : A credit union is an association of people who agree to save their money together and in turn provide loans to each other at relatively lower rates of interest. These are called cooperative credit societies in India. The first credit union was stared in Germany in the year 1848. These are non-profit, deposit-taking and low-cost credit institutions
(6) Middlemen : Middlemen, such as dealers of consumer articles, also grant credit to consumers as part of their promotion campaign. In many cases, dealers work in unison with banks and finance companies, and direct the consumers to the friendly finance companies, This type of arrangement helps dealers maintain a close and loyal relationship with customers,
Advantages of consumer finance
(¹) Enjoying Possession of Goods : An important benefit of consumer credit is that it allows people the possession of goods without having to pay for themimmediately. The user does not have to wait and save money for purchasing a dream product.
(ii) Compulsory Saving : Consumer credit allows for a mechanism of compulsory saving. This has the effect of inducing people into using their income more wisely. It promotes thrift among people and enables people with limited means to acquire goods.
(iii) Easy Mode of Purchase : Consumer credit, through the open account system, offers a convenient mode of acquiring consumer durables.
(iv) To Meet Emergency Needs : Consumer credit is useful in meeting emergencies, such as illness, accident and death, which involve expected expenses. This also helps save the esteem of the consumer in dire circumstances.
(v) Maximization of Revenue : Consumer credit facilitates speedy disposal of goods,which would have remained unsold in the absence of a credit facility to customers. Credit induces more business. This is quite true with regard to non-essential or luxury goods, such as motorcars, trucks, refrigerators, typewriters, all kinds of electrical appliances, TV sets, sewing machines, etc. It is therefore possible for the manufacturers and dealers to secure ever-increasing sales and profits through credit sales.
(vi) Realization of Dreams : Consumer credit is a boon for a consumer who can enjoy The possession of goods without paying for them immediately. The installments can be conveniently paid, spread over a fixed future period. Consumers are in a position to budget for the purchase of even expensive capital items out of their regular, fixed and limited income For instance, it is quite possible for a newly married couple to establish an ultra modern life style and enjoy all the modern amenities of life by acquiring goods immediately, without waiting for the accumulation of savings.
Disadvantages of consumer finance
Despite the fact that consumer credit for costly and durable goods is convenient and beneficial to all parties concerned, one must guard against excessive or indiscriminate credit demands. Consumer credit suffers from the following drawbacks:
(i) Buying Without Thinking : Consumer credit being attractive, tempt people to buy goods indiscriminately. The danger may perhaps lie in acquiring them even if they are not needed.
(ii) Insolvency : Credit forces people to mortgage a substantial portion of their fixed future income. This may lead to insolvency and bad debts on a large scale, which may even ruin the life of the buyer.
(iii) Expensive Credit : Consumer credit, along with its benefit of convenient buying,brings with it the severe consequence of costliness of credit. This is because; the effective rate of interest is much higher than the paper rate of interest. Moreover, the price of goods sold on credit will usually be higher.
(iv) Risk to Traders : Consumer credit poses considerable risk to traders. For instance, in the case of hire purchase financing, although the trader enjoys the right of repossession of the goods sold if the buyer defaults on payments, the articles cannot be sold at full price that would be sufficient to pay for the remaining installments.
(v) Artificial Boom : Consumer credit creates artificial boom in the consumer durable industry. Hence, the economy witnesses only artificial prosperity.
(vi) Risk of Bad Debt : Although the various modes of consumer credit generate a substantial amount of revenue for traders, there is always a danger of bad debts. This may jeopardize the interest of the traders many a time. Similarly, granting credit on liberal terms is fraught with the problem of negative consequence to the business community, which may have the effect of derailing the entire economy too.
(vii) Economic Instability : Indiscriminate consumer credit leads to economic instability, i.e., the recurrence of booms and slumps. In boom time, there is overextension of credit. On the other hand, credit is tightened drastically in times of deflation. In a period of recession, default in payment and the consequent bad debts may create financial difficulties. Liberal consumer credit also leads to over-buying and mortgage of future income to such an extent that nation with a rich stock of durable goods face greater economic uncertainty.