Personal Loan

1. Introduction

A personal loan can be a great way to manage big ticket purchases or expenses like a wedding or a medical emergency. The big plus point about this type of loan is that it doesn’t require the borrower to furnish any collateral for obtaining the loan. Another advantage of a personal loan is that unlike other forms of loans, it doesn’t limit where or how you spend the amount. So while a home loan will allow you to spend only on home purchase, there is no such spending limitation on a personal loan.

2. What needs does a personal loan serve?

With a personal loan, unplanned or emergency expenses can be easily met. With the ease of loan availability nowadays, people are utilizing this product for other expenses like foreign travel or buying a large home appliance. Because it is an unsecured loan, it is made available quickly. This, in turn, helps to meet unplanned expenses like hospitalization costs or treatment of a loved one’s chronic condition. To summarize, the three key reasons why a personal loan is taken are :

1. Personal (health and medication)
2. Family (education, marriage, or holidays)
3. Household (buying a big appliance like AC or TV)

3. Features and benefits

Some of the worthwhile features of a personal loan are:

1. 100% flexibility in how you use the loan amount

Secured loans are restrictive in use – like a home loan where the loan amount can be used for down payment/EMIs of home purchase cost only or a car loan where the loan amount can be used to buy a car only. But, a personal loan carries no stipulation on end use. This feature substantially expands the range of use cases for the bank loan and hence it is increasing in popularity amongst Indian citizens

2. No collateral needed

In many cases, the asset used to purchase with the loan amount itself becomes the collateral (e.g. home loan where the house property itself is the collateral). A personal loan has no such need for a security. This lack of collateral makes personal loan a better option for those who are drawing a good salary but don’t have significant assets to obtain secured loans. Please note that this also means that a personal loan becomes a far riskier product to lend for a lender. Hence they charge a much higher personal loan interest rate than other collateral- based loans like home loans.

4. Essential points to know about personal loan

Before taking a personal loan it is important to know a few essential points about it so that you are certain that you are making the right financial move. Some of these are as below –

1. A lending bank will sanction loan based on the credit history of the borrower. In India, the TransUnion CIBIL Limited (Formerly: Credit Information Bureau (India) Limited) is India’s Credit Information Company that tracks credit scores.
2. Credit score determines the ability of the borrower to repay the loan instalment on time without defaults. Out of a max score of 1000, a score of 750 or above is considered a healthy score.
3. The amount to be repaid is split into a fixed number of installments. The amount comprises of interest and principal amount.
4. A personal loan is generally disbursed in 2-3 days
5. Personal loan interest rate starts from 10.99%. You can research online or use personal loan apps to compare the rates offered and find the bank that offers low interest rates
6. Cash loans carry a maximum tenure of 5 years
7. Personal loans are unsecured loans. The borrower can get loan approval without the need for showing any asset as a mortgage

5. Factors to consider when taking personal loan

Since personal loans carry a higher rate of interest, it is a smart move to check the options available to you and then make an informed decision about which bank to go with and how much to apply for. Check the below measures to accomplish this objective:

1. Needs vs wants

Determine whether the bank loan is for an impulse purchase or for an urgent situation. While it may make sense for medical emergency, it may be wise to defer the holiday plan and save regularly rather than take a personal loan for it.

2. Check out alternatives

Depending on your specific need, check if you have other options available. For instance, for home renovation, you can check if you can get a top up on your existing home loan. This way it will be cheaper as compared to taking a personal loan for this purpose.

3. Exit terms

Check out if you have a better option for exiting the loan. Some banks offer low loan closure charges, while others offer a longer tenure to service the loan. So if you are expecting a windfall or bonus, then it makes sense to go with a lender that doesn’t charge pre-payments or foreclosure penalties.

4. Swift disbursement

You need to check the amount of time taken by the banks to disburse cash loans after the application has been made. Imagine if you are still grappling with the documentation and application process and are not able to get the loan sanctioned in time for the emergency expenditure. You need to have the cash with you when it is needed the most and hence this point is very important.

Remember that at the end of the day, your cash flow will be impacted quite substantially when you are servicing a personal loan. Hence you should be careful to assess your options and then make a decision.

6. Documents needed

1. An ID proof like passport, Aadhaar card, driving license, or ration card
2. An address proof like passport, Aadhaar card, ration card, or electricity bill
3. A PAN Card
4. Salaried employees will need to furnish salary slips, last 6 months bank statements, and form 16
5. Self-employed people will need to furnish last 2-3 years IT returns and bank account statements

7. Why your loan application may be rejected even with good credit score?

Many applicants face the disappointment of personal loan application rejection. A CIBIL score gives an indication of the likelihood of repaying the debt back on time based on your past credit history. Check out what other factors can go wrong even if you have a healthy CIBIL score.

1. CIBIL report comments

In addition to the overall score on the CIBIL report, it also contains remarks or comments. For instance, if you had opted to pay off the past debt in any way other than the standard method, then it will appear as a remark such as ‘written off’ or ‘settled’. Even paying off the debts after a certain number of ‘days past due’ (DPD) will appear as a negative remark.

2. Matching another defaulter’s data

It may happen that your details would inadvertently match a past defaulter. Banks keep a list of defaulters by various characteristics like name, address, ID and address proof details. If some details match (even by mistake), your loan may be rejected. A classic case will be that you move to a new address where a past defaulter might have been residing previously. If you provide this address, then there will be a chance that your loan application will be rejected. You can, however, get your CIBIL report corrected if you notice discrepancies.

3. Acting as a guarantor on a problematic loan

If you had stood as a guarantor on a loan that saw a default, then it will work against you in your own personal loan application.

4. Negative debt to income ratio

Banks consider you overleveraged if your debt repayments leave you with very less income for survival purposes. For instance, if you have a salary of Rs. 50000 and 2 loans of Rs. 15000 EMI each, that will mean that you will be left with just Rs. 20000 for other expenditure. It is highly unlikely that you will get a third loan with this arrangement .

5. Excess borrowing

If you have taken on too many loans, it doesn’t matter whether you diligently pay them back or not. Banks will consider you a risky profile if you borrow in excess.

These pointers will let you work on the negatives and present a good profile so that the chances of your cash loans approval goes up significantly.

8. How to improve loan approval chances even with low credit scores

Now that you know what causes can lead to rejection of personal loan applications, we look at how you can improve your credit and financial profile to avoid the rejection. First thing to know is that this is not an overnight method. You need to work diligently for creating a great credit footprint so that banks view your application in a positive light.

In order to build a credit history, you need to start off early. You can opt for credit to buy smaller durable goods or devices like ovens or laptops. This way, you start building your credit history with prompt repayments in full.

Some FDs offer credit cards secured by the FD. You can use this to buy smaller products and create a more positive footprint of repayment. Since it is a secured card, the likelihood to give in to an impulse purchase will be less.

Hence, using a judicious mix of secured loans and unsecured loans will help you build a better credit history. This will lead to higher credit scores aided by timely repayments without any defaults or penalties.

As a worst case scenario, if your approval is still facing rejection, you can look towards other avenues like NBFCs and peer-to-peer lending. Their due diligence is more lenient than banks, and the chances of approval are much brighter with them. However, it is worth noting that the rate of interest charged by them may be much higher than what banks charge.

Does it make sense to prepay personal loan?

There are certain advantages of closing your loan early in the form of pre-payment or pre-closure. Some of these are as below –

1. Save on interest charges

If a prepayment is done early into the loan tenure, then there is a high chance that you would save a lot of money in the form of expensive interest amounts. Banks carry a lock-in period of 6 months to 1 year. After this period, you have the option to prepay the loan in full. If you have the means to repay it soon after this lock-in period is over, you can save a huge sum. Even if it is late in the tenure, it is best to pay it off and be done with it.

2. Part payment helps

If you get a Diwali bonus, make sure to use the windfall to make part payment for the outstanding bank loan amount. Though it may not be sufficient to completely pay off the loan, it will definitely bring down your tenure and the interest charges payable. Today with personal loan apps and online payment facility, this step can be carried out very easily.

3. Effect on credit rating

Doing prepayment of the loan and closing it will work tremendously in your favor as far as credit ratings are concerned. Please note that part payment will have no impact on your credit rating.

In short, it does make total sense to prepay the personal loan in full as soon as possible, and not stretch the loan for the entire duration of the tenure.

10. Conclusion

A personal loan can be a great financial product only if it is backed by researched based purchase and smart repayments. These guidelines will provide the right direction by letting you know everything there is to know about cash loans. With these guidelines in mind, you can be assured of getting your loan application sanctioned successfully. Do write in to us in case you have any other query around personal loan; we will be happy to clarify.