personal loan

What is a Personal Loan?

A personal loan is also known as an unsecured loan. A personal loan does not require you to put up an asset as insurance against the loan. This option offers both pros and cons.

Pros of a personal loan

Even though you are legally bound to a contract with a personal loan, and should pay instalments in a timely manner, you cannot lose a house or car if something goes wrong. For instance, if you took out a personal loan, lost your job, and can no longer make payments for at least the near future, the institution lending you the money cannot make a claim on your home or car.

  • Paperwork is less
  • Generally, paperwork surrounding a personal loan is much less than paperwork for a secured loan. There's no collateral to check, no extraneous steps necessary to get the loan approved.

    You don't have to divulge information

  • Unless you're running a terrorist operation, the institution lending you the money is not interested as much in what the money is for, than it is in whether you are able to make payments.
  • Personal loans are cheaper than using your credit card
  • Credit card interest could run up your monthly living costs a lot. This is not the case with a personal loan. Getting a personal loan to clear your credit card may even be a better alternative than paying off credit interest.

    Cons of a personal loan

  • Higher risk for lenders
  • Since there is no collateral, the lender may perceive the deal as a higher risk than a home or car loan. This means that your credit profile is subject to scrutiny, which may not be the case if you put up some sort of collateral. If you've not been dotting your i's and crossing your t's, your application might be rejected.

    Higher interest rates

  • Interest rates on personal loans can be enormously high. They can often be double that of a home loan. Here your credit profile plays an important role.
  • Be aware of the deal you accept. Personal loan interest rates vary from institution to institution. Make sure you read the fine print and understand the implications of taking out a personal loan. Check service charges, foreclosure charges and make sure you know of any hidden charges that may apply to your personal loan deal.

When is it okay to take a personal loan?

  • Paying off your credit card dues - personal loans make sense when you have to pay off huge outstanding amounts on your credit cards. The interest rates charged by credit cards are very high, sometimes amounting to 45% per annum. Therefore, taking a personal loan to pay off the credit card turns out to be a good option to reduce the amount of interest you pay.
  • An urgent requirement for cash - because of minimal paperwork, getting a personal loan is a fast process. So if you are really in a tight spot and need some urgent cash to bail you out, personal loans make sense

It is important to understand that personal loans are a good option only if the amount you require is not very big and your monthly budget can easily fit in the added EMI expense. Exercise the option of taking a personal loan, only because you have no other option and it is possible to pay it off in as less a time frame as possible to help you save on the interest cost.

When is it not okay to take a personal loan?

  • Financing the home improvement - in case if you are looking for doing some repairs to your house, opting for a personal loan is not necessary. You can do these repairs with a home improvement loan
  • Buying a car - if you are buying car, a car loan would take care of your needs. You do not need to take a personal loan for that
  • Speculative purposes - Never take a loan to invest in stock markets or other speculative purposes. This is nothing short of a gamble where you might lose out the money invested. Shot term speculative investments are not a wise option to use your money for especially in the instance of having to opt for a personal loan.

Alternatives to a personal loan

Loan against property is a good option that can provide you loan at lower interest rates to the tune of 3-4% lesser. The loan is available at a certain percentage of the property's market value, usually around 40%-60%. LAP interest rates are cheaper by 3% to 4% compared to personal loan rates.

You could also utilise any investments you might have made so far, like shares, securities, fixed deposits, gold, insurance policies etc. You can pledge these as collateral and obtain a loan against them. For instance, you can obtain a loan against the surrender value of your life insurance policy from the insurance company or from a bank or obtain a loan from your provident fund account if you have had an employee provident fund account for more than 5 years. The interest rates would definitely be lower compared to the personal loan interest rates.

So before you decide to go in for a personal loan, check alternatives with lower interest rates. A personal loan may be easy to get but does not necessarily become the best solution.