Personal loans have grown as one of the hottest financial services in which people need to get quick access to money for various needs. This ultimate guide explores the fine nits and bits of personal loans, helping you make well-informed decisions before you apply.
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Table of Content:
- Understanding Personal Loans
- Benefits of Personal Loans
- Eligibility Assessment
- Amount of Loan and Rate of Interest
- Joint Personal Loan Application
- Foreclosure Fees and Prepayment Penalties
- Tax Benefits of Personal Loan
- How to Apply for Personal Loans
- Responsible Borrowing and Repayment
- Alternative Financing Options
- Conclusion
- Understanding Personal Loans
Personal loans are unsecured credit facilities depending on a number of factors like employment history, repayment ability, income level, profession, and credit history. Unlike collateral-based secured loans, which require security, a personal loan allows borrowers to use the borrowed money for anything from paying to fund higher education, organizing a wedding, financing a vacation, or even fixing unexpected expenses.
- Benefits of Personal Loans
- Minimum Documentation
One of the best benefits of personal loans is that the entire process of application is largely hassle-free, and it generally requires only a few documents in contrast to other types of loans. Financial institutions usually ask for documents showing the borrower’s income, place of residence, identity, and academic or professional qualifications, which is relatively hassle-free.
2. Quick Approval and Disbursal
With digital lending platforms gaining the most dominance in the market, the process of approval and disbursement of personal loans has become surprisingly fast. Most lenders now boast of online application channels, which allow borrowers to apply for a loan from their sitting space in their home or workplace. After the proper verification of your documents, the loan amount could be pushed into your account with one or two business days or even hours with some lenders.
3. Flexible Loan Repayment Periods
Typically, personal loans offer the borrower the facility to choose a repayment tenure according to his or her ability to pay. Most lenders offer choices in tenure ranging from one to five years, so one may select a plan according to budget and repayment preference. Shorter tenures have higher monthly installments, but the actual interest payable is lower. Longer tenures have more manageable installments but the cumulative interest charged is higher.
- No Securities Required
As unsecured loans, personal loans do not require the securing of collateral, such as property or assets. It makes them a very interesting product to apply for people who have no collateral or they are unwilling to expose that collateral to the risk of default.
- Eligibility Assessment
Banks and the financial institutions judge the personal loan application based on certain parameters to determine the suitability of the borrower for the loan and their ability to repay the sum. These parameters typically include:
• Income Level: Banks usually consider the applicants with a stable and decent income source because it reflects their repayment capacity.
• Employment Status and History: The continuous employment record or the established business background can strengthen the position of the applicant for the loan.
• Credit History: A person’s credit score, showing their borrowing history and repayment capacity, can be a very important factor in the decision of the bank to grant or reject the loan.
• Other Liabilities: The existing liabilities of the applicant, such as other loans or credit card balances, will also be considered by the banks to avoid overburdening the borrower’s repayment capacity.
- Amount of Loan and Interest
The loan amount the applicant would receive generally depends upon their income level, profession, and the bank’s perception of their creditworthiness. The banks usually cap the loan amount to ensure that the monthly payments are not more than a certain percentage of the borrower’s income, which is often between 40% and 50%.
The personal loans’ interest rates varied significantly from bank to bank and varied depending on factors such as the size of the loan, tenure, and the applicant’s credit report, along with market conditions. It is always better to shop around and consider interest rates and other fees with different banks to get the best deal.
- Joint Personal Loan Application
Most lenders allow the applicant to apply together in co-borrowing with another—such as a spouse, parent, or sibling—which is also an effective means since the combined earning of the two applicants will be considered in calculating the amount of the loan. However, one should bear in mind that a poor credit history of the co-borrower may not speak favorably to the prospects of the loan application.
- Foreclosure Fees and Prepayment Penalties
When a borrower decides to pay off the personal loan before the agreed tenure, lenders usually impose foreclosure fees or prepayment penalty. Foreclosure fees may range from 1% to 2% of the outstanding loan amount and are intended to compensate the lender for loss of interest income. Consider each lender’s policy on foreclosure fees while calculating your finances.
- Tax Benefits of Personal Loans
Personal loans do not have any direct tax benefits but interest paid on personal loans can be claimed as tax deductions under certain conditions:
• House Renovation or Construction: Interest paid on personal loans used for the renovation or construction of a house may be claimed as tax deductible under Section 24(b) of the Income Tax Act.
• Higher Education: Interest paid on personal loans taken for the financing of higher education for self, spouse, children, or eligible relatives may be claimed as tax deductible under Section 80E of the Income Tax Act.
It is always advised to get advice from a qualified tax professional for learning the eligibility criteria and documentation requirements for such deductions.
- How to Apply for Personal Loans
The process of applying for a personal loan is now quite hassle-free with the increased availability of digital lending platforms. Here’s a general idea of the steps involved:
1. Compare Lenders: Research the personal loan offerings of different financial institutions, including banks and NBFCs, to compare interest rates, fees, and terms of loan.
2. Check Eligibility: Utilize the online eligibility calculators or call the lender directly to check your eligibility based on your salary, employment status, and credit history.
3. Gather Required Documents: Prepare the necessary documents, such as proof of income, identity, address, and other documents may be required by the lender.
4. Submit the Application: Fill the application form online or at a branch and submit it by providing correct and true information.
5. Await the Loan Approval and Release of Funds: Your loan application will be processed and approved, and the money will be deposited in your designated bank account.
- Responsible Borrowing and Repayment
While personal loans can relieve your funds, you have to borrow responsibly and manage your repayments wisely. Here are some best practices that could be advisable:
• Borrow Only What You Need: Do not borrow more than you need, especially since too much debt will strain your financials and will be likely to lead to default.
• Create a Repayment Plan: Set a realistic amount for your repayment, ensuring that you pay on time and avoid late fees or penalties.
• Monitor Your Credit Score: On-time repayments will boost your credit score, thereby improving your chances of getting favorable loan terms in the future.
• Seek Professional Advice: If you feel you cannot repay your personal loan, seek advice from a financial advisor or from credit counseling services to determine your options and move forward in that way.
- Alternative Financing Options
While personal loans are convenient ways to finance, it is paramount to look into alternative financing options that may be better suited for your specific needs or financial situation. Here are some alternatives to consider:
• Credit Cards: For minor expenses or temporary financing needs, credit cards provide flexibility, allowing you to make a minimum payment or pay off the balance in full each month.
• Loans Against Securities: Borrowers may become eligible for loans by securing their investments in stocks, mutual funds, or other securities, often at lower interest rates compared to personal loans.
• P2P Lending: P2P lending platforms match you with individual lenders, often charging competitive interest rates with flexible repayment terms.
• Secured Loans: For larger sums or longer tenures, secured loans, such as home loans or loans against property, may provide more favorable terms—at the cost of providing collateral.
- Conclusion
Using personal loans in India, each individual can meet a variety of needs or wishes. So, to understand the nuances of personal loans, assess personal eligibility, compare lenders, and practice responsible borrowing, you can utilize this financing facility to meet your financial goals while maintaining good credit. But remember, it always is good to consider experts in this field and assess your particular conditions before signing any loan agreement.