Many people borrow money for education, weddings, or businesses, but have you ever wondered why some rush into loans or investments without fully understanding the consequences or making logical decisions?
Behavioural finance studies how emotions and biases influence financial decisions, like taking loans without thinking about the long-term impact.
Let’s dive into this concept with a real-life example and key facts.
What is behavioural finance?
For example, imagine you take a ₹ 5,00,000 personal loan in Delhi with a 10% interest rate for 5 years. The loan is advertised as “low interest,” so you feel excited and borrow without checking the full details. In total, you end up paying ₹6,37,440.
This is where behavioural finance helps. The “Low Interest Rate” ad triggered excitement, making you overlook the total repayment. Behavioural finance explains that emotions, like excitement, can cloud your judgement. By being aware of these emotional triggers, you can make smarter financial choices and avoid costly mistakes.
Key Concepts in Behavioral Finance
- Cognitive Biases: Our minds trick us into mistakes through biases like these:
- Overconfidence: You may borrow more than you can repay, believing you’re skilled.
- Fear of loss: You fear losing money, so you hold onto a bad investment, hoping its value increases.
- Anchoring: You focus on the initial loan amount or interest, ignoring the total repayment over time.
- Heuristics: These are mental shortcuts that help you make quick decisions but sometimes lead to mistakes.
For example, you might choose a loan just because it seems cheaper in the short term without thinking about the long-term cost.
- Framing Effects: The way information is presented can influence decisions. For example, a loan with “1% interest” might seem good, but hidden fees or a short repayment term could make it expensive later.
Let’s understand it with an example.
Let’s look at a real-life example to understand how behavioral finance works in the context of taking a personal loan in Delhi.
Meet Ramesh, a 28-year-old office worker in Delhi, who plans to buy a new car and considers a personal loan. The bank offers a 10% interest rate for 5 years, advertised as “low interest.” Excited, Ramesh overlooks the total repayment amount over the five years, focusing only on the interest rate.
Here’s a breakdown of the loan:
| Loan Amount (₹) | Interest Rate (%) | Loan Term (Years) | Monthly Payment (₹) | Total Repayment (₹) |
| 500,000 | 10% | 5 | 10,624 | 6,374,440 |
In this example, Ramesh will pay ₹ 6,37,440 for a ₹ 5,00,000 loan due to interest over five years. The “low interest” framing distracted him from the total repayment. By comparing loan options and reading the fine print, he could have made a more informed decision.
Making Smarter Financial Decisions
When you are considering a personal loan in Delhi, here are some tips to make sure you make a better decision:
- Think about your real needs: Are you borrowing money because you really need it, or because it seems like a good idea at the moment?
- Look at the total cost of the loan: Don’t just focus on the interest rate. Make sure you understand the total amount you’ll repay, including all fees.
- Avoid overconfidence: Just because you have handled money well in the past doesn’t mean you should take on more debt without thinking carefully.
- Be aware of emotional triggers: Don’t let emotions like excitement or fear push you into decisions you might regret later
Fact: As of March 2024, SCBs’ capital to risk-weighted assets ratio (CRAR) was 16.8% and their common equity tier 1 (CET1) ratio stood at 13.9%.
Conclusion:
For instance, Anjali considers taking a ₹2,00,000 personal loan with a 12% interest rate for 3 years. The bank advertises it as “affordable,” but she focuses only on the interest rate, ignoring the total repayment. In the end, she pays ₹2,68,800.
By understanding behavioral finance, Anjali could have realized that the “affordable” loan meant paying ₹68,800 more than the loan amount due to interest. Being aware of emotional triggers and carefully evaluating loan terms would have helped her avoid this extra cost and make a better decision.
