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What to keep in mind before applying for Personal Loan?

Wednesday, August 08, 2012 by Rajiv Raj

pl101n1Kaushik Kumar, 24 earns an annual salary of Rs. 1.8 lakh. With his sister's wedding coming up, Kumar is also expected to contribute a sizeable portion of the wedding expenses. He estimates that he will have to take a personal loan of Rs. 50,000 to make up for the shortfall in the wedding. He's never taken a personal loan before and wants to know what to keep in mind before applying for one.

There are two important factors to keep in mind while applying for personal loans:

  • The repayment period
  • The interest rate

Personal loans are generally offered for periods between 1-5 years. If it's a big amount it may even go up to seven, but that is rare. Now Kumar is a young man and after his sister's wedding we assume that he won't have other huge expenses anytime soon. So it is preferable that he pay off the loan as soon as possible i.e in a year. This could mean that out of a monthly salary of Rs. 15,000 he may have to pay as much as Rs. 5,000 a month toward this loan. This would mean he has to cut down on variable expenditure like movies, eating out and other entertainment expenses for a year. But at the end of one year, he won't have any debt on his books and his credit record will show that he comes under a good risk profile.

The second important factor is that of the interest rate. Banks charge interest rates between 14-25 percent for personal loans. Interest could be charged in three forms: Fixed, floating or flat. Flat rates are the worst ones because your EMI (easy monthly instalment) will be the same every year. For the other two methods, reducing balance method is used to compute interest.

Always take a personal loan from a bank with whom you already have relationship. You can ask them for lower interest rates. Banks allow to you to pre-pay personal loans only after 6-8 months. They try and recover most of their interest costs in the first six months itself. If you have a repayment period of only one year for a personal loan the amount of money saved if you pre-pay a loan after 8 months is very less. Usually you have already paid off most of the interest component and you are only paying back the outstanding principal. Banks levy a high penalty rate for pre-payment. So it doesn't make sense to pre-pay a loan when the repayment period is coming to an end.

Nowadays, a personal loan is the most common loan that people take after they start working. How you deal with this will set the basis for your credit rating and credit score with CIBIL. It is very important that you make your payments regularly and in a disciplined manner. You cannot afford to slip up here. If you default on payments, your credit rating gets affected and your CIBIL score falls. Your credit report will not be a good one.

MadanRajiv Raj

Rajiv is a credit expert with 10 years of experience in personal finance and consumer banking industry and another 7 years in credit bureau sector. Rajiv was instrumental in setting up India’s first credit bureau, Credit Information Bureau (India) Limited (CIBIL). He has also worked with Citibank, Canara Bank, HDFC Bank, IDBI Bank and Experian in various capacities.

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