A personal loan refers to an unsecured loan that a borrower takes out from a bank or a financial institution for their personal needs. Unlike a car or a home loan, a personal loan does not have security against any asset. This means that the borrower doesn’t put up gold/ property as collateral to avail the borrowed money. Therefore, even if you were to default, the lender would have no authority to auction anything you own. Some lenders, however, will put restrictions on what you can or cannot do with the money.
The greater anticipated risk when sanctioning personal loans makes their interest rates to be higher than those on car, gold, or home loans.
Different banks have different eligibility criteria, although there are a few general considerations including, your occupation, age, place of residence, income, credit history, and your capacity to repay the loan. To secure a personal loan requires you to have a regular source of income whether you’re a business person, a salaried individual, or a professional. Lenders will also go to lengths as far as evaluating what kind of business you run, or the type of company that you’re employed with so as to determine eligibility.
How much can you borrow?
The same criteria used to determine if you’re eligible for the personal loan is the same one used to set your borrowing limit. In most cases, lenders will restrict the loan such that your Equated Monthly Installment (EMI) is less than or equal to 40%-50% of your monthly income.
2 key factors that are used to determine the maximum loan that can be lent to you include your liabilities as well as your credit score. A high credit score, say close to 900, is a good indicator of a solid loan repayment history and instills confidence in the lenders that you’re a safe debtor, leading to a high loan limit.
Bear in mind that your current income amount and liabilities (unpaid loans, current EMIs, outstanding credit card dues, etc.) have a direct implication on your repayment capacity.
Most personal loans come as unsecured with fixed payments. This isn’t to say there aren’t other types of personal loans. At the end of the day, the type of credit that works best for you rests on factors such as your credit score and on how much time you intend to repay that loan in.
Types of personal loans
Unsecured personal loans
As mentioned earlier, this is the most common personal loan and is not backed by any collateral such as your property or car. Eligibility for the unsecured personal loan is mainly dependent on your credit score. Rates range from 5%-36%, and you can repay the loan in terms ranging from 1-7 years.
Secured personal loans
As their name suggests, secured personal loans have collateral, which can always be seized by the banks/ lenders should you default on paying the loan. Their low risk for lenders translates to lower rates for you.
Most personal loans have fixed rates. This means that your rate and monthly installments don’t change throughout the life of the loan. Fixed-rate loans especially come in handy for borrowers that want consistent monthly payments. It makes it easier for you to budget, seeing that you don’t have to stress over your payments changing anytime in the future.
These are the exact opposite of fixed-rate loans. Your total interest costs and monthly payments are subject to fluctuations in the benchmark rate, which is usually set by banks.
Borrowers with thin/ zero credit histories may be deemed ineligible to receive a personal loan but it doesn’t mean someone else cannot get it for them. A co-signer stands in for the borrower in case he /she defaults on the loan, and acts as some sort of insurance policy for the lender. The better the credit of the co-signer, the higher your chances of qualifying for a lower rate loan.
Is a personal loan your best option?
Deciding if to apply for a personal loan is as personal as it gets. Be sure to consider the risk involved before making a decision. Borrowing money that you know might cause you problems when paying back, might leave you with all sorts of consequences; the type that could make your life difficult. We’re talking additional charges and interest fees, ruined credit, even bankruptcy.
Still, this isn’t to say that personal loans are a bad situation all the time. If used wisely, every loan is a valuable financial tool.
So, when would a personal loan be beneficial to your needs?
- When you want to borrow cash with a pre-determined interest rate and pre-determined monthly payment. With a personal loan, you can be sure you won’t be slapped with any unexpected surprises along the way.
- When you need money for a particular reason and have a plan of paying it down over time. This could include new tires and paint for your car, a roof you had no intention of replacing, surprise medical bills, or anything else of the like.
- When you are sure you can afford your new monthly payment after calculating using a personal loan calculator.
- When your credit is in fantastic shape.
- When you want to consolidate a debt with high interest into a new low-rate loan. This simplifies your finances and eases your debt repayment journey.
When should you skip a personal loan?
- If you’re struggling to level up with your debts and are in need of more money to stay afloat. This will only sink you deeper into debt.
- If you’re looking for money to fund your college tuition. You’d be better off applying for federal student loans as these offer federal protections and lower fixed interest rates.
- If you want to binge for new furniture or a vacation. There is nothing wrong with spending a lot of money at once, but the best way to treat yourself is to save and pay for it in cash. Besides, what fun is there in buying something you want if you’re paying for it with money you don’t already have?
When applying for a personal loan, it’s best that you go to a bank or lender that you have a standing relationship with. The institution will probably ask to know what you intend to spend the money on and might even have a more desirable way of going about it.
Otherwise, be sure to select your personal loans sensibly and bite only that which you can chew. Take time to calculate your monthly payments and ensure you can consolidate them into your budget. A personal loan can be an asset. You only need to have a sound and executable plan in mind.