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How to Choose Tenure for Personal Loans? Research Team | Posted On Tuesday, September 25,2018, 03:35 PM

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How to Choose Tenure for Personal Loans?



Personal loans are unsecured loans that can be taken for a variety of reasons. Banks generally don’t ask for any collateral to sanction a personal loan. They are also known as “All-purpose Loans” as there is no restriction on the use of the money. Personal loan can be availed for reasons like a wedding, vacation, home renovation and many others. It caters to urgent cash needs and is generally approved in quick time. In most cases, banks don’t ask for collateral while sanctioning a personal loan and it can be obtained with ease.

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Types of Personal Loans

Personal Loans can be broadly categorised into two classes depending on whether or not they require collateral.

  • Unsecured Loan

Unsecured loans do not require any collateral, but take into account the credit-worthiness of the applicant. For loan seekers, this type of loan is more attractive, because should they default in repayment for any reason, there are no personal assets attached to the loan that can be confiscated. Personal Loans are generally unsecured loans.

  • Secured Loan

When the financial institution requires collateral to be given for a loan, it is called a secured loan. This type of loan is typically used to purchase vehicles or other assets and requires an asset to be pledged as security for the loan. Secured loans can be taken at lower interest rates than an unsecured loan, because they are perceived as less risky on account of the collateral.

How to Choose Tenure for Personal Loans?

While availing a personal loan from a bank, it is important to understand how different aspects like interest, tenure and EMIs affect the repayment, and the impact they have on your regular income and lifestyle. One of these important factors is tenure of the loan.

Tenure is the pre-agreed time period (in months or years) between the lender and borrower, for the borrower to repay the principal and interest in full to the lender. Banks offer customers the flexibility of choosing a tenure, that best suits their financial condition, so it is important to make the right choice as tenure has an impact on the interest rates and the EMIs. Therefore, it is important to choose the right time period to avoid any burden on finances.

An inappropriate tenure can lead to unnecessary consequences such as a prolonged loan payment, higher interest rates, higher EMIs and so on. To avoid this, we shall now see what factors are important while choosing the loan tenure.

1. EMI and Interest

Let’s take an example with the assumption that the interest rate doesn’t change with tenure.

For a loan of Rs 2,00,000 with interest rate of 12% and tenure of 4 years, the EMI would be Rs 5,267 with a total interest payment of Rs 52,805. If the tenure is extended by just one year i.e. 5 years, EMI comes down to Rs 4,449, but interest amount increases to Rs 66,933.

Credit score plays a major role in deciding the interest rate. Lower credit scores attract higher interest rates. While it is tempting to go for a lower EMI with longer tenure, the overall interest payment will be higher. As seen in the example, choosing 5 years will increase interest by Rs 14,128 in just a year. However, with a higher interest rate, shorter tenure can be taxing on the budget, and so a longer tenure is advisable.

2. Monthly Budget

The regular income and monthly expenses must be calculated and compared against the repayment terms. If regular expenses make up about 60-70% of income, then it is better to opt for a longer tenure and pay lower EMIs. Paying higher EMIs leaves little room for savings and unplanned expenses. Defaulting in payment or late payments will impact credit score, which will make it hard to get future loans approved.

3. Loan Amount

For smaller loans, a shorter tenure is a smarter option instead of dragging it on for long and paying more interest than is necessary. Higher loan amounts can be repaid in longer tenure, so that the EMIs are not a burden on the monthly budget.

4. Existing Liabilities

Outstanding credit liabilities like previous loan, credit card payments, house rent and school fees must all be taken into consideration while choosing tenure. Make sure that the tenure balances all payments to avoid defaulting on any liabilities.

5. Future Financial condition

If you are aware of a significant improvement in financial condition in the near future, such as a salary hike or bonus, it means higher EMIs will be more affordable. In that case, a shorter tenure will allow for quicker repayment of the loan, even though there is a strain on monthly income for a short time till the salary hike.

6. Prepayment Terms

When loans are taken for emergencies and the borrower has the capacity to prepay the loan in the near future, opting for a longer tenure will ensure lower EMIs till the payment. Banks charge a prepayment fee as a percentage of the outstanding loan amount. So, it is important to be aware of the fees involved and compare the benefits to make a wise decision. If you can pay off the loan early along with the prepayment penalty without much discomfort, then a longer tenure is definitely the better option.

SEE ALSO: Get Personal Loans in Emergency Situations

Most banks offer EMI and Interest calculators on their websites to help get an idea on loan repayments. Using these tools can help get an all-round view of the financial details involved and make an informed decision before availing the loan.

Before taking the loan, it is very important to research the terms and conditions involved and make yourself aware on all charges applicable. Due diligence on the part of the applicant is a must to avoid complications in the future. Default or late payment will drastically affect creditworthiness and in turn, lower the chances of your loan being approved in the future.

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