• Basis

The beginner’s guide to personal loans


What are personal loans?

Personal loans are a form of credit, where you borrow money from the provider and pay it back in monthly installments. Interest rates are typically on the higher end for personal loans because they are unsecured - which means there is no collateral for the loan - unlike a house or a car loan.


What are personal loans used for?

Personal loans can be used for a wide variety of purposes. Some people use personal loans to finance a big purchase, like a car or a home renovation. Others use personal loans to consolidate debt or pay off high-interest credit cards. Some people even use personal loans for a medical procedure or to finance a wedding.


How do I qualify for a personal loan?

To qualify for a personal loan, you will typically need to have a good credit score or a regular income (or both in many cases). Some personal loan providers may also require you to have a cosigner.


Personal Loan example:

Let’s do some quick math to see how personal loans work.

Say you want to borrow ₹50,000 from a personal loan provider. Most personal loans have terms of 1 to 5 years - so we will use a 2-year loan term for our example.

The annual percentage rate in this example is 15% which is also quite typical. Your total interest over two years will be ₹8184, with a monthly instalment of ₹2424. This is calculated after taking into account that your principal amount (of ₹50,000) accrues interest, but you are also paying it back every month in a systematic manner.


The dos and don’ts of borrowing a personal loan

Dos:

  • Borrow a personal loan only if you REALLY need it.

  • Pay back your instalments on time, every time. Defaulting on a payment will adversely impact your credit score which could make it harder to get loans in the future.

  • Check your credit reports every few months to ensure the loan details are being reported correctly to the credit bureaus.

Dont’s:

  • Don’t use personal loans to buy more than you can afford. You must think of a loan as a means to spread out payments, and not as a means to make you buy something beyond what you can afford.

  • Be mindful about who you are cosigning for. If you don't have absolute trust in their ability to pay back as planned, don't sign. If the borrower defaults on the loan, you get penalised.

  • Don’t use personal loans to pay back a less expensive loan - i.e, a loan with a lower interest rate. Also, don’t use personal loans for speculative things like gambling.

Pay off loan or invest extra cash?

Many experts will tell you that it is almost always better to pay off high-interest debt - like credit cards or personal loans - before you start investing. But, there are exceptions to this rule. If your expected rate of return on investments is higher than your loan interest rate, you can continue to invest while paying off the loan in parallel. Say for instance your personal loan interest is 15% but you are expecting returns of 20% on your investments. However, note that this is very hard to execute especially with the rates on personal loans being high.

Bottom line: personal loans can be a great way to finance a purchase you cannot immediately afford, but only if you borrow responsibly.


Don’t forget the fees!

Most personal loans have processing fees associated with them. Make sure you read the fine print and factor in all these fees into your expense calculations. There are also late fees associated with payments that are not made on time. So effectively, what you pay is more than the interest amount quoted.


Final Thoughts:

Personal loans are an expensive form of credit and should only be used as a last resort. That said, they can be very helpful in times of need. Just be sure to do your homework and understand all the terms and conditions before you sign on the dotted line.


Must-know acronyms

APR = annual percentage rate. Fancy word for your annual interest. In our example above, it’s 15%

EMI = equated monthly instalments. The total amount you owe the provider every month

CIR = Credit Information Report. These are generated by credit bureaus such as CIBIL, CRIF, etc that outline your borrowings, repayments etc