Personal loans - 5 things you should know

By virtue of it being an unsecured loan, personal loans have a very high rate of interest attached to it. So one should consider taking a personal loan if and only if

You do not have an asset/security against which you can get a loan. For e.g. if you have a property which is not already a security for a home loan, you can get a loan against property

You have some visibility on your cash flows and are sure that you will be able to repay the EMIs in time. Else you are bound to enter into a debt trap. 

There is an emergency and you need funds immediately. A personal loan can be taken because the processing time is much less on account of minimal documentation.

Opt for personal loans ONLY to meet your essential needs which cannot wait. It should be your last resort (before considering withdrawing cash on your credit card). Taking a personal loan for satisfying leisure needs can prove to be costly i.e. for gambling, buying a new car etc.

What factors will determine your total loan cost?

Interest rate is not the only cost associated to the product. Several charges can be levied which will affect the overall cost of the loan. Hence, rate of interest should not be the only parameter considered while comparing this product across banks. Some of the charges levied include.

Processing fee:  This is charged from the borrower to process the loan application. It is typically between 1 per cent and 2 per cent of the loan amount. Some banks charge a flat fee. This fee is to be paid up front with the loan application and supporting documents.

Pre-payment fee: If the EMIs are paid before the tenure, banks will normally charge the borrowers a pre-payment fee which will be in the range of 2 per cent and 5 per cent of the outstanding loan amount. Usually, pre-payment is permitted only after a certain period of the loan disbursal.

Late payment penalties: If there is a delay in paying off the monthly EMIs, banks will levy a late payment fee with the EMI. It usually is in the range of 2 per cent and 3 per cent.

Cheque bounce charges: If you have given post dated cheques and it is not honoured by your bank on account of insufficient funds, you will be charged a penalty for cheque bouncing. Banks charge anywhere between Rs 250 and Rs 500 for the same.

Documentation charges: These are the charges for verifying the borrower's documents to processing the loan application. Most banks employ a third party vendor to do the same. Charges are anywhere between Rs 500 and Rs 1,000.

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How to select the best personal loan offer?

For selection of a personal loan that will offer you maximum benefits, consider the following factors:

Rate of interest: This will differ from bank to bank depending on their assessment of your risk profile. Factor in your total interest outgo while comparing the total cost of the loan offer between banks.

Other charges: As is stated above, there are several charges levied by the bank which will have an impact on the total cost for you. Hence, let not interest rate be the only factor you consider from the cost angle. Take the total cost into consideration.

Amount of loan: Check if the bank is providing you a loan sufficient enough to meet your financial needs.

Tenure and EMIs: If it is a shorter duration loan, the EMIs will be higher and vice versa. So if you feel you will not have sufficient funds to pay off high EMIs initially, then this factor will be important too. On the other hand a shorter tenure might help you close the loan early at a lesser interest outgo. So take a stand, depending on your monthly budget.

Take all the above parameters into consideration before selecting the bank from which you will take the personal loan.

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How to ensure that you get the best possible rate on a personal loan?

Keep a tab on your credit score: The key to getting the best rate of a personal loan is by maintaining a clean credit history. Your credit history is recorded by the credit bureau which in turn gives you a credit score.

This is shared with banks. Banks will use this as the key parameter for determining the rate of interest on your loan and whether a loan should be provided to you in the first place or not.

Good repayment track record will not only ensure quick approval but also lower rate of interest.

Use your existing relationship with the bank: Banks tend to extend relationship privileges to existing customers in order to retain customer loyalty.

So they may waive off or reduce the processing fee, documentation charges and may offer you a better interest rate than that offered to a non banking customers.

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If you're stuck with a personal loan and are not able to meet the EMI commitments, what should you do?

Try to convert the personal loan which is an unsecured loan to a secured loan against assets such as a house, car, mutual funds, RBI bonds, gold, bank FDs, life insurance policy, shares and debentures by asking the bank to restructure your loan.

Make sure that the EMIs are reduced for an amount comfortable for you to make payments at an interest rate of a secured loan.

If you feel that you're not getting an advantage enough for converting the personal loan into a secured loan, you can separately pledge the assets you have and obtain a loan against them and then with that loan amount, pay-off your personal loan.