More and more people are taking personal loans in India. And if I remember correctly, I read some report that said that the personal loans now form a major chunk of the overall number of loans being disbursed in India these days.
And no doubt, when you are facing a cash crunch and family/friends are unable to help, then personal loans can be lifesavers.
People avail personal loans either from a bank or a non-banking financial company (NBFC) to satisfy their financial needs and many times, their wants (Need Vs Want). But just the intent of taking a personal loan isn’t sufficient. These loans are provided based on key criteria like the borrower’s credit score, their monthly income, ongoing EMIs, repayment capacity, etc.
But yes, personal loans have a comparatively higher rate of interest as these are unsecured and do not require any collateral or security. So the structural risk factors associated with personal loans make them costlier than other secured loan products (like home loan, gold loan, etc.) in the market. But unlike other loans, the amount borrowed can be used for almost anything. The borrower is free to decide the end use of the money. So you can use it to buy a new gadget, for managing wedding expenses, utility bill payments, taking a vacation, etc. And it goes without saying that the amount can also be used to wade over any short term financial crunches. But like all other borrowings, it always makes sense to borrow when you really need money for something important and not just random expenses which are discretionary and not very important. We will discuss this aspect a little later in this post.
Personal loans can be taken by both salaried and self-employed individuals who may be running short of funds to meet their monetary or personal requirements. Fulfilling eligibility criteria is important though.
Though broadly the conditions remain are fairly universal, every lender could still have different eligibility criteria. One needs to check with the lender beforehand and make sure that they do not fall short of any personal loan eligibility criteria. If found so, there are high chances of the loan getting rejected. Let’s see some of the standard eligibility criteria that lenders look upon before sanctioning any personal loan:
- Age Limit: The age limit for being eligible to apply for a personal loan for a self-employed professional is 25-65 years while that for a salaried employee, the age limit is 21-58 years. This is to ensure that the money is lent to people who have sufficient time and income-generating time period to repay the loan.
- Monthly Income: As is natural, the lenders look for a steady flow of income. This gives the lenders a sense of security and assurance that the borrower will pay the borrowed money back to the lender. And generally, a minimum net monthly income of about Rs 25,000 is required to apply for personal loans.
- Nature of Income/Employment: If the borrower’s source of income is not reliable and may face disruption (like job loss, business slowdown, etc.), then that is a genuine risk for the lenders. So the lenders prefer lending to those who have predictable cashflows. And consequently, some of the primary employment types eligible to apply for a personal loan are salaried individuals or self-employed professionals. Another related aspect is the dynamics of borrower’s employment. So if one has been job-hopping in the recent past, getting the loan approval might be challenging. For instance, a lot of lending institutions sanction loans to employees with at least two years of work experience of which one year has to be with the existing employer. And rightly so. Similarly, self-employed individuals must have a minimum of three years of income records.
- Credit Score: How can we not discuss credit score when talking about loans. And since personal loans are unsecured, credit score plays a huge role in determining the interest rate for your loan. A high credit score gives you the bargaining power to negotiate better loan terms for yourself. And what is a sufficiently high credit score that we are referring to? Some banks have a minimum CIBIL Score requirement of 700, while many others might have 750. But you can safely say that a credit score in the range of 700-900 is desirable. So try and maintain a good credit score. This can be done by paying your EMIs, bills on time. Also by making sure that you are not making multiple loans applications frequently. But talking of credit score, a lower credit score does not automatically imply that a borrower would be unable to get a loan. But it may be difficult or another way of looking at it is that lower the credit score, higher may be the interest rate charged by the bank to accommodate for the increased risk.
- Existing Loan EMIs: If you already have loan EMIs which make up about 40-45% of your income/salary, then lenders wouldn’t be willing to lend you. This is a kind of unwritten rule. And rightly so. If someone is using almost half of his/her income for EMI payments, and assuming the remaining half is used for regular expenses, then this person will find it very difficult to pay the EMIs for any fresh loan that he plans to take. Isn’t it?
These are some of the criteria that lenders would be looking at.
Now the personal loans can be of short as well as long term. From a few months to a few years. While long-term personal loans ensure that your EMIs are affordable; taking a short-term personal loan means that you will need to pay less in terms of overall interest. That is how the loan maths work.
Here is an explainer example:
Let’s say you take a personal loan of Rs 10 lac. Now depending on the chosen loan tenure, your EMI and total interest outgo will differ like this:
- 1-year: EMI of Rs 87-88,000 & Total interest outgo of Rs 55-56,000
- 2-year: EMI of Rs 46-47,000 & Total interest outgo of Rs 1.18 lac
- 3-year: EMI of Rs 32-33,000 & Total interest outgo of Rs 1.83 lac
- 4-year: EMI of Rs 25-26,000 & Total interest outgo of Rs 2.51 lac
- 5-year: EMI of Rs 21-22,000 & Total interest outgo of Rs 3.21 lac.
So no doubt the long-term personal loans help you reduce your EMI amounts. So you can split up large and small personal loans alike, over many years, and bring down the monthly cost of your loan. But the total interest paid also increases as the loan tenure increases. Another factor for long term personal loans is that it is known to help build your credit score if the repayment is timely. But I suggest that whenever possible, you should choose the shortest tenure you can manage. As this ensures you do not pay too much interest in the long run. Here is a similar example from home loan space where you can reduce interest paid on shorter home loan tenure.
With regards to the documentation, availing a personal loan these days is a fairly hassle-free process. There is minimal documentation while applying for a personal loan like Income statements, Salary slips and Form 16, Bank statements, Credit report, Age proof, Address proof, Photo identification proof, etc. Not all of them might be required by it varies from one lender to other. And these days several banks and monetary lending establishments also provide online loan application facility as well. If you are someone looking for a personal loan. With the recent surge in digitization across fields, the lenders now have better access to data of their potential borrowers. They know their credit and debit card history and account behaviour. That makes it easier to offer customized unsecured retail loans like personal loans. In fact, you will agree that these days you are already bombarded with pre-approved personal loan offers from all directions. Isn’t it? It is because big data and smart analytics help lenders assess your risk and behaviour quite efficiently. So they are in a better position to lend to people with very short turnaround time.
Are there any alternatives to personal loans?
It depends on the urgency of your need and other factors. These days, credit cards can also be considered but they come with a very high rate of interest which can go up to about 40% per annum. This is an extremely high rate of interest when compared to personal loans. I have already written about this aspect and you can read it in detail at Personal Loan Vs Credit Cards. And if you have an existing active home loan account, then you have the option of taking a top-up loan as well.
I mentioned that people can take personal loans for short term as well as long term. And let’s be fair here that if someone has an unplanned financial emergency, then a loan can be taken without guilt. But if you have known expenses that are coming in the near future, then it should be handled as a financial goal.
Don’t plan to take a personal loan for it in future. Instead, do monthly savings for it in a planned manner. Here is a collection of SIP calculators to get you going.
You can use personal loans to fund your vacation, or to renovate your house or to even partly fund your child’s education! But these are expected (and not unexpected) expenses coming up in the future. So you should ideally save for it first and then spend. How to go about it? Read this simple yet intuitive philosophy of Goal-based Investing.
You will realize that if you clear your head and think logically, Goal-based Financial Planning can help you a lot and sort out your financial life.
Given the nature of people and the dynamics of their money needs, personal loans will continue to remain a solid option to borrow in times of need. But its always best to borrow the minimum possible amount as you need to pay interest on each rupee borrowed. Right?
So even when taking the personal loan route, do your research as there are plenty of lenders operating in the Indian personal loan market. And the interest rate also varies and doesn’t remain the same across lenders. So check the interest rates, service quality and your money needs before you take the personal loan.