What Is A Personal Loan?

A personal loan is a short-term loan, availed by individuals to meet financial needs during an emergency. These loans are given to individuals based on the credit history and ability to repay the loan. Repayment is usually done through fixed-installments called EMIs over a set term. The time-frame of these payments are determined by the specific terms of the loan. The interest rate of personal loan is higher than education loan or secured loans like home or car loans.

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SEE ALSO: How to Get Cheap Personal Loan

What Is A Personal Loan?

For what purposes can it be used?

An individual availing a personal loan does not need to mention the reasons. As it is an unsecured loan, the borrower can use the funds for pretty much anything. Listed below are some of the uses of a personal loan:

• To help repay credit card dues
• To finance a medical emergency
• For wedding expenses
• To fund education or to pursue a professional course
• To start a small business
• For home remodelling or extension purpose.

How personal loans work?

A personal loan is an unsecured loan, which means the borrower does not need to keep an asset as security for the money borrowed. Consequently, the bank charges a higher rate of interest on personal loan than other secured loans. So, there is an agreement between the borrower and the lender where a fixed amount of money is borrowed and it is paid back along with interest as monthly equated instalments (EMIs) over the tenure. Once the loan is paid in full, the loan account is closed.

SEE ALSO: 10 Tips While Taking a Personal Loan

Types of personal loans:

Personal loans can be classified into two categories:

• Secured personal loan - a secured personal loan is the money that you borrow against an asset kept as collateral. The interest rate on secured loan is lower than the unsecured loan. If the borrower is unable to repay the loan, the lender has the right to claim the collateral as payment against the money borrowed.
• Unsecured personal loan - in this case the loan is not backed by any collateral. An unsecured loan is given based on the repayment history and credit score of the individual.

Eligibility criteria for personal loan:

The eligibility criteria of a personal loan are given below:

• Income: the applicant must have stable income which determines repayment ability.
• Age: the applicant must fall within a certain age bracket as specified by the bank.
• Repayment capacity: the applicant must have job stability and must work in an organization for a certain number of years or self-employed with a steady track record of profits.
• Credit score: the applicant must have a good credit score to apply for a personal loan.
• Existing loans: Applicant must not have any other loan liabilities or must have strong ability to bear additional debt.

SEE ALSO: Five Personal Loan Mistakes to Avoid

 How is Interest calculated on a Personal Loan?

The interest on personal loan is calculated based on the factors like credit history, monthly income, the quantum of loan availed and so on. Lenders usually prefer applicants with low credit risk, those who have repaid their previous loans and credit card bills on time. Interest rate on unsecured personal loan ranges from 8 - 24%.

The formula for calculating EMIs on personal loan is as follows:

EMI = [P x R x (1+R) ^ N] / [(1+R) ^N-1]

P = Principal amount

R = Interest rate

N = Number of monthly installments.

Are there any Foreclosure and Pre-Prepayment Charges?

If the borrower decides to pay off the loan before the tenure, then some banks charge an additional fee called pre-payment charges. The pre-payment charges range from 1- 2% of the principal amount.

Some banks also allow partial repayment. Part repayment helps bring down the principal amount that must be paid, which in turn reduces interest.

Where can you get a personal loan?

All leading banks in India offer personal loans based on the credit score of the borrower. There are other places like NBFCs and private lending institutions from which personal loan can be availed. Recently, many online loan aggregators have emerged which disburse personal loans quickly.

Impact on your credit scores:

Applying for a personal loan with a bank can lead to a hard enquiry, as part of the loan approval process. Credit enquiries made by banks and financial institutions on your credit history are called ‘hard’ enquiries. Hard enquiries are made when a credit application is received. Hard enquiries negatively impact credit score and generally lower the CIBIL score by 5-10 points.

Interest rates and other fees

A personal loan has some charges that must be incurred by the borrower. The charges on personal loan are as follows:

• Interest rate: the interest rate on personal loan generally ranges from 13% to 24% a year and is based on the credit score of the borrower.
• Processing fees: the processing fees generally range from 1-2% on the amount borrowed.
• Pre-payment charges: the pre-payment penalty ranges from 1 - 2% on outstanding loan amount.

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