The pros and cons of personal loans

Personal loans are just not about goodies. There are costs too.

If you are yearning to buy that latest gadget or want to furnish your home or go on a vacation, whatever the need, a personal loan can certainly come to rescue. Minimal documentation, no security, flexibility of purpose and quick disbursal are some of the features of a personal loan that make it attractive.

While these needs can also be fulfilled by using your credit card, it could turn out to be an expensive proposition. On account of relatively lower interest burden, personal loans score over credit cards when it comes to purchases which require higher outlay.

Personal loans are unsecured loans and can be used for any purpose unlike other loans such as housing, car or education loans which can be used for the said specific need only. Major banks and finance companies provide personal loans, and for certain purposes, often personal loan is the only available financing option.

But before your begin to believe that personal loan is the best remedy for any short term expenditure, think again. Personal loans come with their set of pros and cons and every loan comes at a cost which is an expense to the borrower. In a high interest rate regime, as exists today, personal loans can be a pretty costly affair.

Saving well in advance for an anticipated future expenditure is the best strategy. Maintaining a contingency fund which can be drawn from in case of an emergency is also helpful. However, if the expenditure was unexpected or funds are inadequate, one may consider taking a personal loan, albeit after understanding the advantages and disadvantages associated with it.

The author is chief evangelist, Perfios.com

Benefits of personal loans

1. Flexibility of use

The main advantage of a personal loan is the flexibility of purpose for which the loan can be used. The loan can be used for any 'personal' need; renovating one's house, medical expenses, foreign trip, marriage expenses, purchasing consumer durables, higher education etc.

2. Minimal documentation

The application process is relatively simple as compared to a home loan or a car loan mainly because no security is required. However, the eligibility of loan depends on the applicant's income, credit history with respect to any other loans and repayment capacity.

3. No security required

A personal loan is unsecured which means there is no need to provide any collateral or security to the lender. While there are certain eligibility criteria which are verified by the banks, absence of any security makes it much easier for a borrower who does not have any collateral such as shares or jewellery to provide.

4. Quick disbursal

It is usually possible to get a personal loan within a short duration simply because it is unsecured and processing time is fast. In case of any contingency such as a medical need, this can provide great relief to the borrower as he can get the funds quickly.

Disadvantages of personal loans

1. High interest rates

Since personal loans are unsecured and the bank does not have any collateral to fall back upon in case of default, the interest rates on these loans are quite high. The interest rates could vary anywhere between 15-25 per cent depending on your credit profile, income level and nature of employment.

If the bank perceives a higher risk in lending to an applicant, it may choose to not sanction the loan or charge a high interest rate. For a borrower, it would also be wise to check with different banks and negotiate on the interest rates since the rates may vary significantly from one bank to another.

2. Credit profile

A lot of importance is given to the credit worthiness of the borrower since the risk in lending is high for the bank. A good credit history with respect to payment of other loans and credit card dues is essential. Also the amount of loan will be dependant on personal income, age, profession, education and repayment capability.

3. Tenure and repayment

The tenure of personal loans is short and loans are usually not given for a period of more than 5 years. Part prepayment is generally not allowed in case of personal loans and prepayment of entire loan attracts a stiff repayment charge. One must go through the fine print carefully for any additional charges or penalties.

Personal loans are ideal for someone who is short of cash for a short term need. These loans are also a better alternative to credit card borrowing which attracts much higher interest. It would also be wise to check with different banks and negotiate on the interest rates since the rates may vary significantly from one bank to another. Needless to say, one must borrow only if there is a dire need to do so. Hence even though personal loans are easy to get, one should be wary of burdening himself with such high interest debt without a compelling reason.