An increasing number of consumers are now taking personal loans for their purchases, especially the big-ticket ones. They are also converting their purchases into equated monthly instalments (EMIs).
Personal loans help the households meet any shortfall they experience in buying a house or a car, in children’s higher education, or even in cases of medical contingencies, among other things.
Here’s a low down on personal loans to understand them better.
What is a personal loan?
Simply put, it is an unsecured loan taken by individuals from a bank or a non-banking financial company (NBFC) to meet their personal needs. It is provided on the basis of key criteria such as income level, credit and employment history, repayment capacity, etc.
Unlike a home or a car loan, a personal loan is not secured against any asset. As it is unsecured and the borrower does not put up collateral like gold or property to avail it, the lender, in case of a default, cannot auction anything you own. The interest rates on personal loans are higher than those on home, car or gold loans because of the greater perceived risk when sanctioning them.
However, like any other loan, defaulting on a personal loan is not good as it would reflect in your credit report and cause problems when you apply for credit cards or other loans in future.
For what purposes can it be used?
It can be used for any personal financial need and the bank will not monitor its use. It can be utilised for renovating your home, marriage-related expenses, a family vacation, your child’s education, purchasing latest electronic gadgets or home appliances, meeting unexpected medical expenses or any other emergencies.
Personal loans are also useful when it comes to investing in business, fixing your car, down payment of new house, etc.
Eligibility criteria
Although it varies from bank to bank, the general criteria include your age, occupation, income, capacity to repay the loan and place of residence.
To avail of a personal loan, you must have a regular income source, whether you are a salaried individual, self-employed business person or a professional. An individual’s eligibility is also affected by the company he is employed with, his credit history, etc.
Maximum loan duration
It can be 1 to 5 years or 12 to 60 months. Shorter or longer tenures may be allowed on a case by case basis, but it is rare.
Disbursal of loan amount
Typically, it gets disbursed within 7 working days of the loan application to the lender. Once approved, you may either receive an account payee cheque/draft equal to the loan amount or get the money deposited automatically into your savings account electronically.
How much can one borrow?
It usually depends on your income and varies based on whether you are salaried or self-employed. Usually, the banks restrict the loan amount such that your EMI isn’t more than 40-50% of your monthly income.
Any existing loans that are being serviced by the applicant are also considered when calculating the personal loan amount. For the self employed, the loan value is determined on the basis of the profit earned as per the most recent acknowledged profit/Loss statement, while taking into account any additional liabilities (such as current loans for business, etc.) that he might have.
Is there a minimum loan amount?
Yes, though the exact amount varies from one institution to another. Most lenders have set their minimum personal loan principal amount at Rs 30,000.
From which bank/financial institution should one borrow?
It is good to compare the offers of various banks before you settle on one. Some key factors to consider when deciding on a loan provider include interest rates, loan tenure, processing fees, etc.
How do banks decide on the maximum loan amount?
Although the loan sanctioning criteria may differ from one bank to another, some key factors determining the maximum loan amount that can be sanctioned to you include your credit score, current income level as well as liabilities. A high credit score (closer to 900) means you have serviced your previous loans and/or credit card dues properly, leading the lenders to feel that you are a safe borrower, leading to a higher loan amount being sanctioned.
Your current income level and liabilities (outstanding credit card dues, unpaid loans, current EMIs, etc.) have a direct bearing on your repayment capacity. Therefore, if you are in a lower income bracket or have a large amount of unpaid credit card bills or outstanding loan EMI, you will be sanctioned a lower personal loan amount than those with a higher income or fewer financial liabilities.
Should I always go for the lowest possible EMI when choosing a loan provider?
Low EMI offers can typically result from a long repayment term, a low interest rate, or a combination of the two factors. Thus, sometimes, you may end up paying more interest to your lender if you choose low EMIs. So use online tools like the personal loan EMI calculator to find out your interest payout over the loan tenure and your repayment capacity before taking a call.
Rates
Being unsecured loans, personal loans have a higher interest rate than those on secured ‘home and car’ loans. At present, many leading banks and NBFCs offer such loans at interest rates of as low as 11.49%. However, the rate applicable to a borrower is contingent on key factors, including credit score, income level, loan amount and tenure, previous relationship (savings account, loans or credit cards) with the lender, etc.
Extra charge payable
Yes. In addition to the interest payable on the principal amount, there is a non-refundable charge on applying for a personal loan. The lender charges processing fees, usually 1-2% of the loan principal, to take care of any paperwork that needs to be processed as part of the application process. The lender may waive this charge if you have a long-term association with him.
Fixed or floating interest rates
For a fixed rate personal loan, the EMIs remain fixed. Floating rate means the EMIs keep decreasing as it follows the reducing balance method of calculating interest payout on a personal loan. As per the new Marginal Cost of Funds based Lending Rate (MCLR) rules, floating rates may be changed either on a half-yearly or annual basis.
Difference between reducing and flat interest rate
As the name implies, in the former, the borrower pays interest only on the outstanding loan balance, i.e., the balance that remains outstanding after getting reduced by the principal repayment. In flat interest rate scenario, the borrower pays interest on the entire loan balance throughout the loan term. Thus, the interest payable does not decrease even as the borrower makes periodic EMI payments.
Can I apply jointly with my spouse?
Yes, you can apply for a personal loan either yourself (singly) or together with a co-applicant (jointly), who needs to be a family member like your spouse or parents. Having a co-borrower means your loan application will be processed in a higher income bracket, making you eligible for a larger loan amount. However, keep in mind that if you or the co-applicant has a poor credit history, the chances of success of your loan application may be low.
Prepaying loan
Yes, however, some banks allow borrowers to prepay the loan only after certain number of repayments has been made. Some lenders do not allow partial prepayment. Prepayment charges may be levied on the outstanding loan amount.
Key documents required when applying for a loan
Though the documentation requirements vary from one financial institution to another, some key documents you will have to provide with your personal loan application include:
*Income proof (salary slip for salaried/recent acknowledged ITR for self-employed)
*Address proof documents
*Identity proof documents
*Certified copies of degree/licence (in case of self-employed individuals)
Repaying the loan
It can be repaid in the form of EMIs via post-dated cheques (PDC) drawn in favour of the bank or by releasing a mandate allowing payment through the Electronic Clearing Services (ECS) system.