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9 Things to Watch Out For While Taking a Personal Loan - Outside View by PersonalFN
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9 Things to Watch Out For While Taking a Personal Loan
Oct 26, 2016

Mr Hemant Mankame is a 53 year old Chartered Accountant and his daughter Jinal is getting married in a couple of months. According to Mr Mankame, the wedding expenses total Rs 35 lakh. Mr Shah calculates a shortfall of Rs 15 lakh. He plans to apply for a personal loan.

Mr Mankame has already got his credit score checked through CIBIL. (A credit score is a statistical number that depicts a person's creditworthiness. It offers a snapshot of his/her personal debt repayment history at a single point in time. It lets a potential lender know the risk that they are taking by lending you money. In general, higher the score; lower is the risk of default. Some of the credit information bureaus in India are CIBIL, Equifax, CRIF-High Mark, etc.)

Every bank Mr Mankame approaches, be it public and private sector banks, has something or the other to offer him. The idea is to lure him as a customer. Some offer flexible payments while others offer a discount on the processing fees.

Mr Mankame is confused because of the overflow of information.

Which bank or financial institution should he choose?

Through today's article we share some of the important parameters that any borrower should assess before signing on the dotted line.

  1. Interest rate: All personal loans in India are categorised as unsecured. So, the interest rates are higher compared to other secured loans (i.e. home loans, car loans etc.). The interest rates are in the range of 11%-25% p.a. The period ranges from 1-5 years.

    The table below indicates the total cash outflow cost for a personal loan of Rs 15 Lakh. The period of the loan is assumed as 5 years.

    Loan amount (Rs) Interest rate Term of the loan (years) EMI (Rs)

    (rounded off)

    Total cash outflow (Rs)
    15,00,000 11% 5 32,614 19,56,840
    15% 35,685 21,41,100
    20% 39,741 23,84,460
    25% 44,027 26,41,620

    (Note: The above table is for illustration purpose only)
    (Source: PersonalFN Research)

    A higher interest rate is a burden on one's wallet, evident from the table. So ideally, opt for a personal loan with a competitive rate.

  2. Repayment flexibility: In addition to the regular repayments on your personal loan, it is useful if it allows additional lump-sum repayments. This flexibility helps in repaying the loan ahead of time. Avoid signing up with an institution that penalises early repayment.
  3. Processing fees: Processing fees change from bank to bank. Some banks charge a fixed fee, while others charge a percentage of the approved loan amount. There are some banks which don't charge a processing fee at all.

    A higher processing fee impacts the total cash outflow. And should be borne upfront whether you end up taking the loan from the bank or not.

  4. Good customer service: Can you access your personal loan details online? This will enable you to keep track of the loan/s and perhaps, allow you to be in better control of your finances facilitated by additional repayments. Besides, evaluate if queries on your account are answered efficiently. While borrowers will have varying customer service standards, there are some basics of good service that are universal.
  5. Period of the loan: The shorter the loan tenure, the better it is. The table below total cash outflow under different periods.
    Loan Amount (Rs) Interest rate Term of the loan (years) EMI (Rs) Total Cash Outflow (Rs)
    15,00,000 15% 1 1,35,387 16,24,644
    2 72,730 17,45,520
    3 51,998 18,71,928
    4 41,746 20,03,808
    5 35,685 21,41,100

    (Note: The above table is for illustration purpose only)
    (Source: PersonalFN Research)

    Looking at the table, a layman may choose a personal loan for a 5 year term considering a smaller EMI. But you would be paying a higher interest cost with a longer term in play. Therefore, the total cash outflow would be higher as the term increases.

  6. Salary: A salary highlights the repaying capacity of the borrower. A lender requests a borrower to furnish the latest salary slips. A salary is considered adequate based on the loan applied for, expenses, outstanding loans (if any), and the city of residence, etc.
  7. The company you work at: Almost all Indian banks categorise employers based on size and popularity of the company. If your employer falls under the highest category, you may be eligible for a higher loan amount at a lower rate of interest and vice versa.
  8. Job Term: Banks and other lenders may analyse the time period you have been working at the current job and even the number of years of work experience. A higher time span in your present job may work in your favour while procuring a loan. Lenders may also visit your employer to verify your details.
  9. Your current economic life cycle: A bank may not be hesitant in granting you a loan if you are settled and future prospects of earnings are bright, plus if you are residing in your current house for long.

To Conclude...

Although your credit score is extremely important to apply for a personal loan, these 9 factors play a crucial role in selecting a bank and type of loan. As highlighted above a personal loan charges a high interest rate. It should be opted only as a last resort.

Here is a final checklist before applying for a personal loan:

  • Ascertain the amount you want to borrow.
  • Calculate how much you can afford to make in repayments.
  • Evaluate how long it will take to pay off, and how frequently you want to set the repayment cycle (weekly, fortnightly or monthly.)
  • Will a fixed or variable rate personal loan suit you?
  • Compare personal loans online, look for one with a lower interest rate and lower fees.
  • Organise any documentation and paperwork that is required to support you application and have this ready.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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