Introduction
A personal loan is perhaps the most versatile financial product that enables individuals to avail money without any collateral. For medical needs, education, house renovation, wedding costs, or debt consolidation, personal loans are a quick means of handling financial requirements. Prior to application, however, it is essential to know the ins and outs of personal loans such as interest charges, eligibility, and repayment tactics.
This complete guide will assist you in knowing all about personal loans, allowing you to make wise borrowing choices while maintaining your financial well-being.
1. What is a Personal Loan?
A personal loan is an unsecured loan offered by banks, non-banking financial institutions (NBFCs), and online lenders. As it does not involve collateral, lenders judge borrowers on the basis of their creditworthiness, income, and repayment ability.
a) Personal Loan Features
- No Collateral: Unlike car or home loans, personal loans have no security or collateral.
- Fixed Tenure: The tenure of a personal loan is usually 12 months to 60 months, but some banks offer flexible repayment options.
- Fast Processing: As there is less documentation involved in a personal loan, approvals are generally quick, at times within 24 hours.
- Higher Interest Rates: Personal loans carry higher interest rates compared to secured loans because there is no collateral.
- Usage Flexibility: Personal loans can be used for any reason, such as medical bills, weddings, holidays, education, or consolidating debts.
2. Interest Rates on Personal Loans
Interest rate is perhaps the most important component of a personal loan since it dictates the borrowing cost. It differs with each lender and is based on several factors.
a) Types of Interest Rates
- Fixed Interest Rate: The interest rate is constant during the loan term, guaranteeing fixed EMIs.
- Floating Interest Rate: The rate of interest varies according to the change in market conditions, and this can result in fluctuating EMIs.
b) Determinants of Interest Rates
- Credit Score:
- A credit score of 750 or more assists in availing lower rates of interest.
- A lower score can mean higher interest or rejection of the loan.
2. Stability of Employment & Income:
- A stable job and increased levels of income minimize loan risks and yield reduced interest charges.
- Those employed through themselves will generally experience only minutely elevated rates.
3. Duration of the Loan & Size of the Loan:
- The loan could receive lower rates of interest based on greater denominations.
- Greater tenors have a tendency to carry more rates owing to the increased lender risk.
4. Internal Policies of Lenders:
- Every bank and NBFC possesses an exclusive risk-measurement model that determines interest rates.
c) What’s the Key to Obtain Best Interest Rate?
- Pay your credit card dues and EMIs promptly and enjoy a good credit score.
- Shop around for loan quotes from several lenders to secure the best price.
- Look at applying directly with a co-applicant to improve eligibility and obtain better rates.
3. Personal Loan Eligibility Criteria
Lenders consider the borrower before approving a loan, based on some eligibility criteria. The borrower is more likely to get the loan approved if they meet these parameters.
a) General Eligibility Requirements
| Criteria | Salaried Persons | Self-Employed Persons |
|---|---|---|
| Age | 21-60 years | 25-65 years |
| Type of Employment | Private/Public Sector Employee | Business Owner, Freelancer |
| Minimum Income | ₹20,000 – ₹30,000 per month (depending on lender) | ₹3-5 lakh per year |
| Work Experience | At least 1-2 years | At least 2-3 years of stable business |
| Credit Score | 750+ | 750+ |
b) Determinants of Loan Eligibility
- Debt-to-Income Ratio (DTI):
- Lenders like a DTI of less than 40% (total monthly debt payments must be lower than 40% of income).
2. Employment Type & Stability:
- Salaried individuals employed with well-known companies or government sector jobs have better chances of approval.
3. Existing Liabilities:
- If you have more than one loan or credit card loans, lenders might not be willing to give a new loan.
4. Loan Amount Requested:
- The amount of the loan must be reasonable in relation to the income and repayment capacity of the applicant.
c) Documents Required for a Personal Loan
- Identity Proof: PAN card, Aadhaar card, Passport, or Voter ID.
- Address Proof: Utility bill, Passport, Aadhaar card, or rental agreement.
- Income Proof: Salary slips (for salaried applicants), ITR and bank statements (for self-employed applicants).
- Employment Proof: Offer letter, business registration certificate, or GST registration.
4. Sound Repayment Techniques for Personal Loans
Proper management of loan repayment helps in ensuring financial stability. The following are some best practices for efficient repayment of personal loans.
a) Choosing the Appropriate Loan Tenure
- Shorter Tenure: Increased EMIs but less total interest.
- Longer Tenure: Reduced EMIs but increased interest outgo.
b) Prepaying & Part-Payments
- Prepaying part of the loan decreases the outstanding principal and interest burden.
- Verify if there are any prepayment penalties before making lump sum payments.
c) EMI Auto-Debit Setup
- Setting up EMI auto-debit eliminates missed due dates and late fees.
- Assists in having a good credit score.
d) Not Over-Borrowing
- Take only the required amount, since borrowing more creates financial tension.
e) Loan Balance Transfer
- If there is a lower interest rate from another lender, refinancing can save EMI expenses.
- Make sure that processing charges and transfer fees do not exceed the savings.
5. 5 Common Mistakes to Avoid When Taking a Personal Loan
- Not Considering Credit Score: Using a low credit score can lead to rejection of the loan or excessive interest charges.
- Failure to Compare Lenders: Compare several loan offers before choosing a lender.
- Not Checking for Hidden Charges: Look for processing fees, late payment charges, and prepayment charges.
- Taking Higher Tenures Without Necessity: Longer tenures minimize EMIs but maximize the interest amount.
- Borrowing More Than Necessary: Borrowing a higher amount than necessary can result in repayment troubles.
6. Personal Loan vs. Other Loan Types: A Detailed Comparison
Before taking a personal loan, it’s necessary to compare it with other loans to decide which borrowing option suits your requirements best.
| Loan Type | Secured/Unsecured | Interest Rate | Loan Amount | Repayment Tenure | Purpose |
|---|---|---|---|---|---|
| Personal Loan | Unsecured | 10% – 24% | ₹50,000 – ₹50 lakh | 1 to 5 years | Any personal expense |
| Home Loan | Secured (collateral: property) | 7% – 12% | ₹10 lakh – ₹5 crore | Up to 30 years | Property purchase/construction |
| Car Loan | Secured (collateral: vehicle) | 8% – 15% | Depending on car value | Up to 7 years | Car purchase |
| Gold Loan | Secured (collateral: gold) | 7% – 14% | ₹10,000 – ₹1 crore | Up to 3 years | Emergency funds |
| Education Loan | Secured/Unsecured | 8% – 15% | ₹50,000 – ₹50 lakh | Up to 15 years | Education costs for higher studies |
| Credit Card Loan | Unsecured | 24% – 48% | As per credit limit | Short term (3-24 months) | Small unexpected expenses |
A personal loan is appropriate when you require money urgently for some personal purposes, while other loans are used for specific needs like purchasing a home, vehicle, or studying.
7. Role of Credit Score in Personal Loans
A credit score is a three-digit numerical value reflecting your creditworthiness. It is a key factor in whether you get a loan, at what rate of interest, and how much loan amount.
a) Credit Score Range & Its Effect on Loan Approval
| Credit Score Range | Chance of Approval | Interest Rate Provided |
|---|---|---|
| 750 – 900 | High approval probability | Low interest rates (10%-14%) |
| 650 – 749 | Moderate approval probability | Moderate interest rates (14%-20%) |
| 550 – 649 | Low approval probability | High interest rates (20%-24%) |
| Below 550 | Very low approval probability | May be rejected for loans |
b) How to Improve Your Credit Score?
- Pay EMIs and Credit Card Bills on Time – On-time payments increase your credit score.
- Avoid Multiple Loan Applications – Excessive applications reduce your score and reflect greater credit dependence.
- Lower Credit Utilization Ratio – Keep credit card utilization at less than 30% of the limit.
- Have a Good Credit Mix – A mix of secured (home/car loans) and unsecured (personal loans) loans will help create a healthy credit history.
- Monitor Your Credit Report Periodically – Make sure there are no mistakes that impact your score.
A strong credit score enhances your chances of securing a personal loan at lower interest rates and favorable terms.
8. Alternatives to Personal Loans
Before opting for a personal loan, consider other financing options that may offer lower interest rates or better terms.
a) Loan Against Fixed Deposit (FD)
- Interest Rate: 1%-2% higher than the FD rate
- Loan Amount: Up to 90% of the FD value
- Best For: Individuals with FDs who need immediate funds without breaking their deposit.
b) Gold Loan
- Interest Rate: 7%-14% (lower than personal loans)
- Loan Amount: Based on the gold’s value
- Best For: Short-term cash needs with lower interest rates.
c) Loan Against Property (LAP)
- Interest Rate: 8%-12%
- Loan Amount: 50%-70% of the market value of the property
- Best For: High borrowing requirements with lower interest rates than personal loans.
d) Credit Card EMI Conversion
- Interest Rate: 12%-24%
- Loan Amount: Depending on credit card limit
- Best For: Small bills which can be converted to EMIs.
Although personal loans are versatile, other loans can have lower interest rates based on eligibility and collateral available.
9. Personal Loan Scams & How to Avoid Them
As online lending platforms grow, fraudsters are targeting borrowers more and more. Here’s how to avoid them:
a) Common Personal Loan Scams
- Scams of Upfront Fee – Scammers request an upfront processing fee but never release the loan.
- Phony Lenders – Impostors represent themselves as real lenders, extending loans at astronomically low interest rates.
- Phishing Attacks – Scammers trick applicants into divulging bank information or OTPs.
b) How to Recognize a Legitimate Lender?
Verify if the lender is registered with RBI or a well-known financial institution.
Check online reviews and the official website for verification.
Never pay advance fees prior to loan approval.
Avoid lenders who provide “guaranteed approval” even with bad credit scores.
Securing yourself from scams guarantees a safe and secure borrowing experience.
