Personal Loan Basics

Personal loans have become increasingly popular in India. For example, from as of 2018, 12 million Indians had an outstanding personal loan balance, up 25% from 2017. These financial products clearly provide useful funding for those that need money for large or unexpected expenses. In this article, we cover everything you’ll need to know in order to understand personal loans and begin your own financing search.

Table of Contents

Why Apply for a Personal Loan

Personal loans offer individuals a relatively easy way to quickly obtain a large amount of cash. This can be very helpful for situations such as unexpected medical procedures, weddings or moving expenses. However, we do not recommend using personal loans or other long-term financing in order to pay for unnecessary short-term costs. That being said, personal loans in India tend to charge lower interest rates than those of credit cards, making loans a good option if you desperately need cash.

Pros of Personal LoansCons of Personal Loans
  • Fast Availability: Most personal loans in India make cash available to you within a few days. This is a important factor for those who need financing for an emergency expense.
  • High Interest Rate: Personal loans charge higher rates than specific-use, secured loans and in some cases, higher rates than credit cards. For this reason, a personal loan should be a last resort option.
  • Unsecured: Unlike a secured loan, personal loans do not typically require collateral, so the consequence of not paying your debt is less severe than not repaying your home loan, in which case you could lose your home.
  • If you have excellent credit, you may be able to find cheaper methods of borrowing, such as home loans against property. However, you should be very careful about using your house as collateral.
  • Flexible: Personal loans can be used for a range of purposes, unlike specific-use loans, such as home or student loans.
  • Banks tend to view specific use loans as less risky, making these types of loans less expensive.

How Do Personal Loans Work?

Once you are approved for a personal loan you will receive a lump sum of cash that you are required to repay over a set period of time, or loan tenure. In India, personal loans are offered with fixed and floating interest rates and borrowers are required to make payments based on their loan’s interest rate and current balance. Additionally, most personal loans are fully amortized, which means that their monthly payments consist of interest and principal charges. This makes these loans somewhat easier to budget for as there are no balloon payments at the end of the loan term. As an illustration, we’ve detailed the cost structure of an example personal loan of Rs. 20,00,000 over 3 years.

Example loanDetails
Loan AmountRs. 2 lakh
Interest Rate15% p.a.
Processing Fee2.50% of loan amount (Rs. 5,000)
Loan Tenure3 years
Monthly PaymentRs. 6,982.14
Total Interest CostRs. 51,356.90
Total Cost of BorrowingRs. 56,356.90

Types of Personal Loans

There are three main types of personal loans available to consumers in India through banks and other major lenders. For example, personal installment loans provide a sum of cash upfront, which borrowers are required to repay on a monthly basis. This is the most common form of personal loans and is often used to pay for large personal expenses such as medical emergencies or weddings.

Credit lines are another type of personal loan. These financing products allow borrowers to draw money whenever they need it. Typically, these credit lines have maximum limits set by the lender. Additionally, these loans only charge interest based on the actual of money and time you end up borrowing, which means that you could actually save money if you repay your debt quickly or only draw a small amount. A final type of personal loan is called a balance transfer. This kind of loan allows you to transfer your outstanding debt to one new loan. Some lenders will even give you a grace period, during which you are charged no interest. This can be a helpful type of financing for borrowers that need to consolidate and reduce their overall personal debt.

Do I Qualify for a Personal Loan?

At this point, you may have decided whether you require a personal loan. However, you might not understand how to even begin the process of obtaining the right loan for your needs. First of all, it is important to make sure that you qualify for a loan in the first place. For example, most banks have income requirements of at least Rs. 20,000 per month and prefer that borrowers are employed with salaries. Banks also consider your credit history as part of their lending screening process. With that said, it is important to be aware of a variety of loans available for individuals of different employment and income situations. For instance, many banks offer loans to low-income earners or those that are self-employed.

Personal Loan Application Process

Once you’ve decided to apply for the personal loan of your choice, you must fill out an online application form and submit several documents. These documents help banks understand your financial situation and include proof of income and current debt levels.

Example Documents Typically Required for Personal Loan Application

Required DocumentSalaried ApplicantNon-Salaried Applicant
Proof of IdentityPassport, Drivers License, PAN
Proof of AddressPassport, utility bill
Proof of IncomeBank statement, Salary accountAudited financials, bank statement

Before you apply for any financial product, you should be confident that you have found the best option given your circumstances. Although personal loans are usually cheaper than credit card debt, they still charge a fair amount in total interest costs. For this reason, it is essential to be sure that you make a thoughtful decision to take out this kind of loan.

First of all, you must be sure that you will be able to repay your loan before you borrow. If you default on a personal loan you can seriously damage your credit score, which can have significant consequences down the road. Only borrow for personal expenses such as a wedding or vacation if you know that you will be able to make the payments.

If you are nervous about being able to afford a loan, you may want to reach out to your family or friends to see if they would be willing to lend you money. While this may be awkward, it could help you avoid financial disaster if you would not be able to repay a traditional bank loan.

Finally, if you are borrowing for a specific-use such as to purchase a vehicle or to attend university, make sure that you have considered all other options before taking out a personal loan. Banks tend to offer loans to charge lower interest rates to borrowers that need funds for a specific use or to purchase an asset such as a home or car.

Once you decide a personal loan is the best financial tool for you, make sure you account for the monthly payment of the loan and manage your budget so that you are able to always make on-time payments.

William Hofmann

William is a Product Manager at ValueChampion Singapore, helping consumers and SMEs find the best banking products through comprehensive analysis of data. He previously was an Economic Consultant at Industrial Economics Inc, where he conducted a variety of research and economic analyses. He graduated from University of Vermont with degrees in Economics and Psychology. His work has been featured on a variety of major media such as the Straits Times, the Business Times, the Edge, DailySocial, the Entrepreneur and more.