What is Personal Loan?
Personal loans are diversified and easily available loans to cover the financial needs of individuals. It is a flexible financial product with varied rates, terms, and types for individuals having different credit profiles. These borrowings are convenient to access as collateral is not required, forming a common choice for different personal purposes. Banks, online lenders, or credit unions offer personal loans. The repayment period of these loans is between one to seven years. Personal loans have helped individuals manage their finances without headaches, from financing a dream wedding to covering medical emergencies.
Geeky Takeaways:
- There are different forms of personal loans: secured, unsecured, consolidation debt loans, and personal lines of credit.
- Lenders mostly offer Unsecured personal loans where they don’t require collateral.
- On the other hand, secured personal loans require collateral and they are offered with lower interest rates.
- Personal loans can be used for a variety of purposes including organizing a wedding, paying off medical debt, consolidating debt, or financing a home renovation project.
- The lenders offer interest rates on personal loans depending upon the credit history and other criteria of the borrower. A lower interest rate is offered to borrowers having a credit score of 750 and a CIBIL score of 850.
Table of Content
Types of Personal Loan
There are different types of personal loans offered by different financial institutions, banks, and online lenders with customized terms and conditions. Borrowers need to fulfill the basic eligibility criteria for availing a personal loan from the lenders. The following are the major types of personal loans offered by lenders:
1. Unsecured Personal Loans
The unsecured personal loans are offered to borrowers with any collateral. It is unsecured for the lenders. There is a risk associated with it as the loans are not protected using any collateral. They have different features are versatile and can be used for a variety of purposes. This unsecured loan is offered to individuals solely based on their creditworthiness. The borrowers need to pay higher interest rates for smaller loan amounts.
Features
- Non-Requirement of Collateral: In unsecured personal loans, the key feature is that there is no requirement for collateral, for example, any asset like a car, home, jewelry, etc. to cover the loan.
- Creditworthiness of Borrower: Lenders offer loans to individuals who have a good credit score, regular income, and stress-free financial flow. Only these factors are required for availing of this type of loan.
- Interest Rates: These types of loans either have fixed interest rates (same rate during the term of the loan) or variable interest rates (fluctuating rate during the term of the loan) depending on the terms of the lenders.
Advantages
- Easy Access: Individuals who do not possess any significant assets or are not willing to use them as collateral, can avail of these unsecured personal loans.
- No Risk: This advantage is for borrowers who fear risking their assets if they are unable to repay the loan. Unsecured loans offer zero risk to personal assets.
- Fast Approval Process: Since these loans do not evaluate or verify any asset, extra paperwork is reduced. Thus, the approval process becomes faster.
Disadvantages
- High Interest Rates and Small Loan Amounts: As there is greater risk to the lenders, they charge higher interest rates compared to the secured personal loans. Along with higher interest rates, they offer limited loan amounts to borrowers who have poor or average credit scores.
- Potential for Default: If an individual is not able to repay their loan, the lenders might use other debt collection techniques that would affect the credit score of the individual and also lead to legal action.
- Penalty for Pre-Repayment: If you repay the loan before the term period, the overall cost of the loan might increase and this penalty is used by some of the lenders.
Example
Suppose you visit a bank (say ICICI Bank), and seek a personal loan, based on your credit score and other eligibility criteria you will be offered a loan of (say ₹3 lakhs) with a fixed rate of interest (say 9.99%) for 3 years. This means, within 2 year period, you need to repay the loan. In this process, no collateral is required. Only monthly EMI needs to be paid to repay the amount.
2. Secured Personal Loan
The secured personal loans come with some form of collateral such as your home, car, or any asset of the borrower. It is secured for the lender to lend the amount to the borrower. Less risk is associated hence, the interest rate is also lower.
Features
- Higher Loan Amounts Sanctioned: As lenders have lower risk associated with unsecured loans, they offer higher amounts of loans to the borrowers.
- Collateral Required: Unlike unsecured personal loans, secured loans require collateral as they are secured for the lenders. If the borrowers default, then the collateral can be used to recover the loan amount.
- Low Interest Rates and Long Repayment Period: Here, as there is lower risk to the lenders, they offer lower interest rates and an extended repayment period. As the amount is huge, they allow borrowers to repay the amount in a longer duration.
Advantages
- Low Interest Rates and Huge Loan Amounts: Lower interest rates and higher loan amounts are a boon for the borrowers. Lenders feel lower risk and hence, they have the flexibility to offer lesser interest rates with huge loan amounts.
- Credit Score Improvement: Timely repayments of the loan amount, can significantly improve your credit score which will make it easier to apply for another loan if required. A good credit score signifies good borrowing behavior.
Disadvantages
- Risk of Losing Collateral: As secured loans have collaterals associated, being a borrower it is riskier to avail of this loan, you might lose your asset if you fail to repay your loan. Collaterals might include any asset such as a home, vehicle, jewelry, etc.
- Longer Approval Process: Compared to unsecured loans, the loan approval process is longer as the lender evaluates and verifies the collaterals.
Example
Suppose you wish to renovate your home and require a loan amount say (₹8 lakhs). You approach a lender who would pay you the amount but in return would require collateral. You agreed to use your car as the collateral which had a value worth ₹10 lakhs. The repayment period offered by the lender is say 7 years. You and the lender both agree to the terms and conditions, and you avail the loan for your home renovation.
3. Debt-Consolidation Loans
Debt consolidation as the name suggests amalgamates multiple debts into a single debt and this helps in paying lower interest rates. This type of personal loan can improve your credit score.
Features
- Monthly Multiple Payment Reduces to Single Payment: As multiple loans are combined under a single loan window, the multiple monthly premium amount also becomes a single payment amount. Different payments might create a chaos, thus debt-consolidation helps in smoother repayment.
- Interest Rates are Lower and Fixed Repayment Tenure: Multiple debts have different payment charges. Single debt payment reduces the interest amount. Further, there is a fixed repayment period where you can plan your debt budget and clear off your debts within time.
- Combination of Multiple Debts: As debt consolidation loans are offered to cover other loans, they help in repaying other loans. They cover credit card bills, personal loans, medical expenses and other debts.
Advantages
- Reduced Interest Rates: Debt-consolidation loans are offered with lower interest rates and they help to cover multiple other debts. Instead of repaying multiple interest charges, a single interest charge is beneficial to repay off other debts.
- Ease of Finances: Managing personal finances where multiple loans are linked to it. A single loan amount eases the complicated personal balance sheet. Using debt consolidation loan, you can keep track of your finances and ease out your repayment pressure.
Disadvantages
- Requirement of Collateral: Based on your credit history and terms of lender, collateral might be required to avail debt consolidation loan. Thus, there arises a risk of losing your collateral in terms of non-repayment of the loan.
- Extra Charges: There might be extra charges linked to this loan such as closing costs, origination fees, pre-payment penalties, etc. Before availing this loan, read the loan terms and conditions properly.
- Extended Debt Repayment Period: There is a risk of lengthy repayment period as debt consolidation loans offer lower monthly premiums. The overall cost and time of all the debts must be kept in mind before availing this type of personal loans.
Example
Suppose you borrow an unsecured personal loan along with a car loan and home loan. You can simplify your loan repayment by availig a debt consolidation loan to ease out your expenses. This loan would offer you lower interest rate and also would pay off all your debts.
Conclusion
There are multiple personal loans in the market and being a responsible borrower, you need to look and weigh each terms and conditions of the personal loans. Every financial institution, banks, and online lenders have their policy and terms and conditions. Always make sure to read them before applying for a loan. Also to create a good credit score, it is suggested to apply for loans and also repay them within due time.