Guarantor Liability

While learning about the nomination rules for various investment avenues, I got into thinking about the rules related to being a guarantor. The term is typically confused with a reference required sometimes. It is very common to see friends asking their office colleagues or family friends to become a loan guarantor.

I am sure that most people would be very willing to help the needy friend by readily becoming a guarantor without understanding the full implication. The most common mistake happens because a guarantor is thought of as a reference. The problem is that, in the ambit of law, a guarantor is much more than just a friendly reference.

The definition itself tells a lot

“A guarantor for bank loans means a person who promises to provide payment on the loan, or other liability in the event of default.”

It is pretty obvious why banking institutions asks for a guarantor, since lending money is always a risky business with lot of chances of default by the person taking loan. So guarantor is like another chance for the bank to recover the loan money. But with a huge liability, why would anyone want to be a guarantor? A father would readily be a guarantor for his son’s education loan due to emotional reason, but others are gullible enough to not understand the liability of a guarantor and the legal implications.

What happens on a loan default?

If you are guarantor to your friend’s loan and he defaults (essentially not paying the EMI), what do you think will happen? You would think that the bank will chase your friend for the payment. Also if he is unable to pay, bank may pursue a legal course against your friend for recovering the loan amount.

Well here is the shocker!! The bank can actually issue a legal notice to you as a loan guarantor along with chasing your friend for recovery. Supreme Court indicates:

"The legal position is clear that liability of the guarantor and principal debtor are co-extensive and not in alternative," said a Supreme Court Bench comprising Justices Dalveer Bhandari and H L Dattu bursting the myth that the principal debtor had the primary liability to pay up a defaulted loan.

In plain language, the bank (or who-ever lends the money) has full right to pursue both the primary debtor (who took the loan) as well as the guarantor at the same time.

            Liability of guarantor is exactly same as that of person taking the loan.

It is important to note that a guarantor involved in a defaulting case would have a negative impact on guarantor's credit history as well. Also once a default has happened, there is very little a guarantor can do except to talk to lender and borrower and try to make a settlement.

So be very careful when providing a guarantee, since being a guarantor is akin to taking the loan yourself without getting the money.

Nomination and weird rules

I am regular reader of JagoInvestor and recently came across this awesome post on nomination by Manish. I thought, I was well versed by the nomination rules and understood the concept about the difference between nominee and legal heirs. Well, to my surprise, I did find some shockers and it left me amazed by the absurdity of the old rules which probably needs some change.

I would suggest you go through the entire post, but here are the two shockers that hit me:

1) Nomination in Shares: In the basic sense, a nominee is just entitled to receive the money disbursed by the company and is responsible for distributing it to the legal heirs. But in case of shares, the nominee is the one who is the owner of the shares unless you have left a will. Here is what Manish writes

It means that if you have not written a will, anyone who has been nominated by you for your shares will be the ultimate owner of those stocks, The succession laws on inheritance will not be applicable but in case, you have made a will, that will be the source of truth.

2)  Nomination in PPF: I am just quoting Manish verbatim:

Let me give you some shock first. If you have Rs 10 lakh in your public provident fund (PPF) account and you have not nominated anyone for your PPF account, your legal heirs will get maximum of Rs1 lakh only! Yes, it’s so important to have a nominee, now you get it . You can nominate one or more persons as nominee in PPF. Form F can be used to change or cancel a nomination for PPF. Also note that you cannot nominate anyone if you open an account for a minor.

This is a real shocker, since in both cases, it becomes absolutely mandatory to have nominee assigned as well as a death-will clearly mentioning whom you want the money to go after your death. The conclusion is that you have be absolutely careful while filling nomination forms and you should plan for leaving a will. Thank you Manish for the wonderful post.

UPDATE: One of the interesting aspect about, not having a nomination for the saving account and when you try to claim that money as a legal heir, is that the banks fix a threshold limit of the money lying in the saving account, within which bank only expect a letter of indemnity for any claim. But if the money lying in the saving account is more than the threshold limit, then banks needs multiple documents (Letter of Indemnity from all claimants, Claim Form signed by all claimants etc), and it will try to make enquiries that there are no other claimants to the money lying in the saving account. Another thing which banks needs in this case is “Surety”. A surety is a guarantee to assume responsibility arising out of any future claimant for the money in the saving account.

The threshold limit can vary from bank to bank (for e.g. State Bank of Mysore has a threshold limit of Rs 50K[PDF]). So say if you want access to the money in saving account of your deceased parents in State Bank of Mysore, if the balance is < Rs 50K  you just need to furnish letter of indemnity, but if the balance is more than that (say 2 Lakh), apart from multiple documents that you need to submit, you may have to submit a surety of amount much larger than the balance (may be  say Rs 5Lakh) depending on the bank.

Future of Credit Cards

Remember Aamir Khan in Ghajini giving credit card to the chaat-wala? Well, the credit cards have almost become ubiquitous at-least in the urban India and I think it wont be long before it would engulf the far-reaching rural areas including the chaat-walas. Although I do hate credit card, but there is no doubt that this is going to be the default mode of payment in future.

The credit card companies make a load-full of money sometimes not by ethical means but they are also spending a lot of money in the future technology of credit card which may be more secure and more useful for the end consumer. So what’s the future of credit card? Here are some glimpses:

1) Multi Account Credit Card

The Multi Account Credit Card has two buttons on its face each with an indicator light. So you can essentially have two accounts in the same card. You can also have a credit and a debit card rolled into one. The card contains a lithium-polymer battery inside can last four years under high usage. They're also fully waterproof,

 

2) The Hidden Credit Card

This card does not display all the digits of your account number and some digits are hidden. This credit card has a keypad and black-and-white display for six of the digits in the card's unique number. Once the correct PIN is entered on the card's four buttons, the missing digits are filled in and the card's magnetic strip is populated with data. Both the digits and the strip become blank again after a short time. If the card is lost, no-one can use it.

3) Contact Less Credit Card

These are essentially chip-cards that works on the RFID mechanism. The idea is that you do not need to swipe and you can just wave the card in front of a special RFID scanner who can charge your card quickly. The RFID chip can transmit a lot more information without having to dial in to a network. American Express says its ExpressPay transactions are 63 percent faster than using cash. I guess, if this technology works out, then the chip may be implanted in other devices like watches or cell phones (already available e.g. Nokia 6131 NFC) and who knows may be in the human body itself.

4) Citibank’s 2G Cards

The Citibank 2G cards are special cards that allow users press the request-rewards button before swiping the card for paying with their card points. The action of pressing the buttons changes the data imprinted on the magnetic stripe.

Check out the video for the demo of some of these cards

There are definitely lot of issues with the new technology that should be sorted before these become the de-facto credit cards. The key point for getting these technologically advanced cards relies in the adoption strategy by the millions of vendors who have already spent money for the infrastructure of today’s simple credit card. So they definitely would need some incentive to switch to advanced technology. Also the security is going to be utmost significance especially for contact less credit cards. I hope we see these soon in India, since I expect that these advance cards will bring more security to the end consumer.

Infrastructure bonds not really tax-free

In my office there was a lot of hype over investment in the IDFC Infrastructure bonds which were recently issued. These were considered as a great investment vehicle by most of the websites/media channels, goading the retail public to take part in the issue.

I felt that the biggest mis-information regarding these infrastructure bonds is the notion of it being tax-free. Also the problem is compounded by the introduction of section 80CCF in the IT Act by the government which allowed additional window of tax deduction of investments upto Rs 20,000.

But as I mentioned earlier that there are lot of caveats to investing in these infrastructure bonds.  The biggest confusion most retail investors have is that the bonds are tax-free, but they are not. The interest received from these bonds are actually taxable and it has been mentioned in the prospectus of the IDFC Infrastructure bond[PDF] as well (check page 29). The current IT Act does not exempt the interest earned through these infrastructure bonds although the tax at source (TDS) is NOT deducted. 

The 20,000 Rs additional tax deduction window is too small for any significant benefit. So if you fall in the highest bracket you save at the most Rs 6K a year. The interest earned by you at the rate of 7.5% to 8% will get lower after you include the interest in your taxable income and pay tax on it.

Also most investor think that investment in these bonds is as secure as a fixed deposit, but in-fact these are not as secure. The investors should visit the Risk Factors (Page 46) in the PDF to become aware of the risk in these investments.

I suggested in my earlier post to wait before investment and now I would suggest to invest only if you want to diversify your portfolio to include these bonds, otherwise I would suggest an equivalent investment in mutual funds (higher risk appetite) or in gold (higher gains with lower risks) since these avenues are much better than infrastructure bonds in the current form.

UPDATE: The tax-free bonds typically signify that the investment amount can be used against tax reduction, but I feel that it creates a confusion and should only be applied to EEE type of investments.

NOTE: Dhirendra Kumar, Value Research have similar thoughts.

why I don’t like IPO investment ?

COAL India, a navratna company is set to launch its Initial Public Offering (IPO) tomorrow. The Government has fixed the Coal India Ltd initial public offer (IPO) price between Rs 225 and Rs 245 a share. At this price band, government expects to mop up between Rs 14,211 crore and Rs 15,475 crore from the issue that will open for subscription on October 18.

In last few months, I have seen IPO advertisements for so many companies(Coal India, Eros International, Career Point, Prestige Builders, Cantabil Retail, Jaypee Infratech etc just to name a few), that it looks like an IPO surge has hit the Indian Stock Markets.

The basic reason why such an IPO deluge is coming in the Sep-Oct month this year, is the bullish secondary market. The stock market is typically driven by sentiments which are currently extremely positive due to the large influx of FII money being pumped into Indian Stock Market.  And this is the reason I hate IPO investments.

The IPO route is great for the promoters who can mop a good amount of cash riding on the bullish stock market and most investors look at it as a mechanism to make quick bucks.

The problem is the IPO hype created by companies and underwriters (who are essentially salesman for the IPO) by creating a huge amount of excitement and pro-claiming it as a once in a life-time opportunity. The side-effect of this over-hype is that retail investors jump-in the IPO bandwagon regardless of fundamentals of the company. And this is the reason I consider it as an extremely risky way to invest my hard-earned money. 

The price of an IPO is something you can not control while buying and the promoters/underwriters would like to have the IPO price as high as possible. One of the glaring example is the Reliance Power IPO, where most retail investors have lost money.

So I have decided not to put my money into any IPO, but that is just my opinion. If someone does due diligence before investing in IPO, then it may be a good bargain.

So what should be looked at in the IPO before investing? Here are some basic points:

1) Promoter Background: Check the promoter credibility, previous ventures and if any legal cases pending on the promoter.

 2) Historical Performance:  The same due diligence is required to buy IPO as you would look for stocks in secondary markets. Check at least the last five year performance. 

3) Valuation: Check out the industry peers valuation along with the company’s valuation. 

4) Purpose of IPO: Check the reasons for the promoters to look for more money through IPO route. 

5) Risk Factors: Check various analyst reports, IPO prospectus and other ways to identify the risks involved.

If you have done your research and are confident about the IPO, go ahead and best luck for making good money!!

Investment technique - Ladder strategy

My father advised me to stay away from risky investments like stocks and to make Fixed Deposits as sole investment way. But times have changed and stocks/mutual funds are the ‘in’ thing, but Fixed Deposits still remains one of the most important mechanism to lock your money.

Fixed Deposit provides you a method to lock you money for a specific period ensuring a fixed interest rate. The problem with FD is that your money is locked for the specific period and if you break it between tenure, banks impose a heavy penalty. Also a shorter term FD gets you lower interest than a higher tenure FD. I just took a look at the HDFC bank website for interest rates and realized that 1-2 years FD interest rate is very close to interest rates for 5 years or more FD, while significantly less interest rate for tenures less than a year.

This leads to a dilemma of choosing between liquidity and higher interest rates, when investing in Fixed Deposits.

FD laddering comes to rescue. The concept is very similar to rupee-cost averaging.  The idea is to stagger the FD maturity over a period to get higher interest rates as well as access to partial amount of your investment at regular intervals.

Let me explain using a simple example. Consider an example that you plan to have around Rs 50,000 over 5 years of period say for your children’s education or down-payment of your house. But you may also fear that locking such amount for longer duration may not be prudent due to emergency needs. So instead of saving the money in 5 years fixed deposits, the strategy should be :

 Invest 10,000 Rs in FD with tenure 1 Year

Invest 10,000 Rs in FD with tenure 2 Year

Invest 10,000 Rs in FD with tenure 3 Year

Invest 10,000 Rs in FD with tenure 4 Year

Invest 10,000 Rs in FD with tenure 5 Year

So essentially you staggered the investment across 5 years in different tenure. The advantage is that you get higher returns but also access to partial amount of your money at regular interval.

As the FD matures, you may decide to roll-over the FD into next 5 year FD.

In essence the advantages of laddering are

1) Lower holding period risk

2) Reduce interest rate fluctuations

3) Creates Liquidity

4) Provides regular income

5) Avoid pre-mature withdrawal penalty 

Why you should NOT buy gold coins?

[Picture courtesy Nii Noi]

Gold prices are hitting the roof as indicated by the current prices of INR 1909.71 per gram. The www.goldprice.org indicates the movement of the gold.

This may be a decade of increasing gold prices and an amazing CAGR of ~17%. The website accurately describes gold as

Gold has been called a "barometer of fear." When people are anxious about the economy - they turn to gold and bid the price up. Gold has the remarkable ability to store value in both deflationary and inflationary times.

In India, most people invest in gold through jewellery since that has been a traditional and safe method perceived by many households. But in recent times there have been many different means through which you can buy the gold, like gold coins, gold bars, gold ETFs, stocks of gold mining companies etc. As a consumer buying physical gold either in the form of jewellery or in the form of coins/bars is still prevalent over the EFT/Stock route, especially given the household trust over the local jewellers.

I have realized over the period is that buying gold coins is not a profitable proposition compared to buying jewellery or investing in ETFs. The most common mechanism to buy gold coins is either through local jeweller, but apart from that a lot of Indian banks sell gold coins. The Indian post office also sells gold coins and some of the nationwide sellers like Tanishq too sells gold coins.

The problem in buying gold coins are manifold, especially not in terms of buying process but if we look from an investment perspective.

• Buying gold coins from non-reputed jewellers often pose the problem of gold purity. Typically in India you get 24 as well as 22 Carat Gold coins.


• Buying gold coins from reputed banks and post-office incur a premium over the price you may get from local jeweller. The premium reduces your overall investment gain.


• The biggest issue with gold coins is that banks/post-office does not buy back the gold coins and you have to sell it to local jeweller if you wish to en-cash it. The local jeweller will happily buy back your gold coin but with a significant reduction in selling price and sometimes also incurring a “melting” charges which could be totally random depending on jeweller. I have given 1.5-2% as melting charges.


• Another issue is that if you buy gold coins at one local jeweller and try to sell at another (think of re-location) you again will get significantly lower charges. The local jeweller is willing to buy their own gold coins at current selling rate, but impose some or the other charge when the same purity coin is from other jeweller.


• I have also faced the issue that most local jeweller will agree to exchange of gold coins if you are buying some jewellery from their shops, thereby deducting the coin value, but if you want cash, they simply refuse it. Also if some jeweller is willing to pay back in cash, there you have to accept a lower selling price compared to current market price.


• It is also important to be aware of many cheats (including reputed jewellers) who can con you without you even knowing it. Here is a technique, some jeweller provide you with a nice packing of the gold coin (of the size of credit card), mentioning all the relevant details on the packaging. Since you would trust the jeweller and also since you are in a hurry (especially during festival seasons) you would not ask him to remove the gold coin from the packing and weigh it. I had the experience that when I wanted to sell it the jeweller opened the packaging and found it less in weight than what is mentioned.




So if you are looking for investment in gold, I recommend either buying a jeweller (some of the big jewellers are now coming up with no making charges) or to invest in Gold ETF, which are hassle free and more liquid compared to gold coins.