Loans are the most popular among all the financial products today, and form the base of any bank or lenders product portfolio. It’s among the primary functions of a bank to lend money and earn an income in the form of interest when the loan is repaid.
There are different types of loans, most commonly sorted according to the purpose for which they’re being taken – car loans, for example only go towards funding the purchase of a car, home loans can only be spent on building or buying a home, etc. Banks and lenders keep track of spending in this way, and usually keep the asset (car, home, etc.) being funded as collateral in case the borrower isn’t able to repay. Since there is a specific (tangible) purpose for which the funds are being taken – which also serves as collateral – the bank can rest easy knowing that if the borrower isn’t able to repay the loan, it still won’t suffer a loss.
Personal Loans are a little different from other loan products in the sense that they can be used at the borrower’s discretion, and usually do not need to be secured by any collateral or guarantor (although this depends on the bank in question). Personal loans are also given for fixed tenures and with slightly higher rates of interest. These types of loans have strict eligibility requirements and some proof of your ability to repay them – a credit history, or bank statements that show you have a regular stream of income that’s enough to cover your EMIs.
What can a Personal Loan be used for?
Personal Loans are special because they can be used for anything, at the discretion of the borrower. The cash disbursed in a personal loan can be used for anything from funding your vacation to starting a business, or meeting emergency medical expenses, or even repaying a debt that has a higher interest.
The amount disbursed through a personal loan has no strings attached with relation to where the funds are being directed.
Any large infusion of funds you require can be met with a Personal Loan.
Why are Personal Loan interest rates higher than other loan products?
The primary reason for this is that Personal Loans are unsecured by their very nature. The bank takes an additional risk that you may not repay your loan (or may be rendered unable to repay your loan) as there is no collateral or security. This is also the reason that personal loans are more difficult to have sanctioned by the bank.
In a home loan, for example, failure to repay would mean that the bank can legally seize your property (or a part thereof) in order to compensate for the unpaid amount that the bank regards as a loss. Personal loans have no such guarantee.
Features of Personal Loans
- Fixed Tenure: Personal Loans can be short or long-term depending on your requirement, but always have a fixed repayment tenure. Loan tenures are stated in the number of months in which the EMIs have been divided. Typical Personal Loan tenures are 12 months, 18 months, 24 months, etc.
- Fixed Loan Amount: Personal Loans have fixed loan amounts between a particular range, depending on your creditworthiness. Different banks have different minimum and maximum loan amounts, varying the range of loan amounts that can be disbursed – and the amount that you can borrow.
- Credit scores: Your credit score (from a credit information bureau like Equifax or Experian) can be the deciding factor on how much of a loan amount is disbursed to you, and could also be the deciding factor on whether your loan is sanctioned or not. Credit scores also determine the total loan amount that can be sanctioned, and the interest rate applicable. A better credit score can get you a higher loan amount at a lower rate of interest – as the bank will have a sense of confidence in your ability to repay your loan.
- Unsecured nature: Personal Loans are not secured by a guarantor or any collateral, unless specifically requested by your bank. While this means that the bank cannot legally seize any of your valuable personal property, it also means higher interest rates and the requirement of a good credit score. The banks also have different methods of collecting what’s owed, and can take legal steps if necessary.
- Fixed interest rates: The interest rates on Personal Loans are fixed and do not change for the tenure duration of that loan.
- Slightly higher interest rates: Personal Loans have slightly higher interest rates than other secured loan products – this is for a number of reasons like no security, and no information on when, where, and how the money is going to be spent.
- Flexibility of using loan amount: The loan amount that’s been sanctioned can be used for any purpose without having to intimate the bank on the same. The money can be used to cover contingencies, emergency medical expenses, or even just as extra money for a vacation. Although it’s advised to only take a loan if you’re confident in your ability to repay it.
- Minimal Documentation: Personal Loans do not require the long process of asset verification and document authentication. Personal Loans simply require documents that verify your identity, address, and ability to repay.
Keep in mind that while longer tenures mean you’ll be paying lesser each month, the total amount paid will eventually be higher. Shorter tenures mean paying a bit more each month, but the total amount paid will be lower – as the interest is charged every month.
Documentation required for Personal Loans
In most cases, the following list of documents should suffice for sanctioning a personal loan:
- Proof of Identity: The bank needs to verify your identity and age, and hence requires a photographic ID proof. This could be your passport, driver’s license, etc.
- Proof of Income: The bank needs to verify whether you’re capable of repaying the loan, and whether you’re able to meet EMI payments. The bank will not disburse a loan whose EMI payments are more than 50% of your monthly take home income.
- Proof of address: In order to verify your address, the bank requires you to submit some authentic document verifying your current address.
- Loan application: This is the form you’ll be filling in at the bank itself (or online, if your bank has that facility). It contains details like the amount of loan you require, where you intend to spend it (in some cases only), the desired tenure, EMI options, etc. for the bank to get the process started.
- Proof of creditworthiness: This is for the bank to decide what loan amount you can be trusted with, how much interest you’ll be charged, and what tenure you’ll be comfortable with.
Personal loans must be taken after careful consideration of your actual requirements, and calculation of interest with an EMI Calculator to see how much you’ll eventually be paying as compared to how much you’re borrowing.