When a bank lends to an individual it is usually for a carefully defined purpose like buying a home or obtaining higher education.
By contrast a personal loan is a much more flexible loan which can be used for a variety of purposes: say paying for a wedding, re-decorating your home or an expensive holiday.
Most major banks as well as some finance companies offer personal loans and for some purposes they may be the best, or even the only way, to obtain finance.
What are the advantages and disadvantages of a personal loan?
The main advantage is the flexibility of using the money for whatever purpose you intend. Secondly personal loans are usually unsecured which means you don't have to offer security or obtain a guarantor.
Finally there is less paperwork involved since the bank doesn't have to verify assets used to secure the loan which also means that these loans are approved more quickly.
The disadvantage is that these loans are relatively difficult to obtain and the qualifying criteria are stricter than for other loans. The rate of interest is also higher than for most other loans and may be as high as 25 per cent particularly if your credit profile is weak.
What determines the size of a personal loan and interest rates?
The size of the loan you are eligible for depends mainly on your personal income; other variables include your age, profession, education and your history of repaying other loans.
Typically you may be able to obtain a loan around twice your annual income up to a limit of Rs 10 lakh. It may be possible to club the income of your spouse in order to increase your loan eligibility.
Interest rates also vary according to your profession. Generally salaried workers in reputed firms have to pay a lower rate of interest whereas self-employed workers, particularly those who aren't professionals, have to pay a higher rate of interest.
Apart from interest rates are there other charges?
Yes and it's important to read the fine print to see what additional fees are associated with the loan. If possible try to negotiate down these charges. Such charges may include a processing fee which covers the cost of processing your application and documentation charges to cover the expenses of verifying your documents. In addition you will to have pay service tax on both interest payments and other charges.
What is the documentation required?
The main documentation is a proof of identity and proof of residence (passport, voter ID etc.) as well as a proof of income. The latter can be a salary slip for salaried individuals or an income tax return for the self-employed.
Repayment of personal loans
Typically personal loans will be offered for a period of 1-5 years and are repaid on a monthly basis through EMIs (equated monthly installments). Prepayment is possible but will generally carry a significant prepayment charge.
If interest rates fall it may be possible to shift a personal loan from one bank to another to take advantage of the lower rates to reduce EMIs.
Tips for using personal loans
~ Personal loan rates are negotiable and you should negotiate hard to reduce your rate. If you have a good repayment record on other loans use that as a negotiating point.
~ Shop around at different banks as there is a fair amount of variation in the rates offered. In addition to interest rates make sure you compare other charges as well.
~ Personal loans usually charge a lower rate of interest compared to credit cards. If you have large credit card dues, paying them off through a personal loan may be a good way of saving money.
More from rediff