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Pros and Cons to Know Before Taking Personal Loans

Personal finances should be managed in a way that a situation does not arise where one has to borrow money. But this is an ideal scenario. There are moments in life when funds are required – urgently. In such times, retail users look at various financing options. Personal loans are one such popular option available in the market.

It helps to know that personal loans are different from consumer loans. Personal loans are referred to as all-purpose loans or multi-purpose loans because they can be used for different purposes.
Usually, lenders do not levy any restrictions on the use of such loans. These come to the rescue when purchases have to be made and cash is not readily available.

Personal loans are also a great way of getting out of financial debt. In times of pressing needs, these are literally lifesavers. A personal loan can help fund personal needs like education, wedding, medical expenses, and any other emergency. Such loans have to be repaid with interest over the tenure of the loan. The eligibility of loan depends on factors like the applicant’s age, present income, repayment history, and credit score.

Personal loans can be easily availed from banks and financial institutions in India. What needs to be kept in mind is that a personal loan has advantages and certain disadvantages. Prior knowledge of both ensures that the borrower makes an informed decision.

Features of personal loans are:

Flexibility of Use
One of the main advantages of a personal loan is the flexibility it offers. The loan is multi-purpose in nature; i.e. it can be put to different uses. A borrower can utilise the funds for things like home improvement, purchasing of jewellery, paying for wedding expenses, among other things. Once the eligibility criteria are satisfied and the loan is disbursed, no questions are asked on its final use.

No Collateral Requirement
There are two types of personal loans – secured and unsecured. Secured personal loans have to be backed by collateral like property, whereas unsecured loans do not have such requirement. If the borrower defaults in case of a secured loan, the lender has the right over the collateral. This is not the case in unsecured loans. Personal property is not at risk in the event of default. Unsecured loans are best suited for individuals who do not own assets like land, home, or property. The most common type of personal loans in the market is unsecured loans. 

Simple Application and Quick Disbursal Process
Personal loans can now be availed online in addition to the offline mode. The application process has been simplified by all banks, thereby ensuring quick approval and disbursal of funds. In some cases, this takes less than 24 hours. Even the documentation required is less as compared to other types of loans, which make these the preferred choice in case of emergencies. A positive credit history and credit score ensure quick approval and disbursal, as long as proof of a secure and stable income is provided.

Beware! Don't take so much burden of debt, that it ultimately becomes unbearable.

However, despite their apparent benefits, personal loans do have their share of disadvantages. The main ones are:

Interest Rates linked with your credit profile
Lenders decide the rate of interest depending on the applicants’ credit profile and income. They start from as low as 11.49% and can go up to 25%. Another factor that comes into play is that unsecured personal loans are riskier in nature, as they do not require collateral as security against the loan. In the case of default, the lender faces higher risk as it will be difficult to recover the money. To cover this risk, lenders charge a higher rate of interest resulting in larger monthly payments, as compared to other loans. The rate, however, depends on the borrower’s credit score, income stability and the amount of loan sought. It helps to know that lenders often hide a portion of high interest rates in upfront fees such as loan origination and application fees. Before signing loan documents, one should ensure that the monthly payment amount is within budget.

Quantum of Loan May Be Smaller
Banks and lending institutions go to great lengths to reduce the risk of default when offering personal loans. One way they do this is by limiting the quantum of loan disbursed. A low credit score and lack of stable job further reduce the chance of obtaining a large loan. Lenders also conduct extensive background checks to gauge the borrower’s repayment ability.

High Credit Score Requirement
Personal loans are generally unsecured in nature, therefore lenders levy stringent requirements to cover the risk of non-payment. They stipulate a high credit score to offset the inherent nature of unsecured personal loans where collateral security is not mandatory. A low credit score and unfavourable credit history may even lead to a rejection of loan application. Sanctioning of loan is subject to basic eligibility criteria based on the applicant's creditworthiness.

Heavy Penalty
In the event of default of an unsecured personal loan, one where the loan is not backed by personal property, the lender may still be able to place a lien on the borrower’s assets to recover payment. One also needs to understand that lenders make a profit only when a borrower defaults – by charging a heavy rate of interest. When funds are not forthcoming, the lender sues the borrower in court. This results in additional expenses like lawyer fees, court costs and miscellaneous expenses to the original loan and late fee charges. The borrower’s credit score is adversely affected reducing chances of securing a loan in future. In the event of a successful lawsuit, he/she may even have to forfeit his/her current salary.

Final Word
Whatever be the personal circumstances, one should dispassionately compare the pros and cons of a personal loan and then take a decision to borrow. Unsecured personal loans have many advantages – one can obtain a loan without going through a strict underwriting process. Besides, such loan can be put to a variety of uses. On the other hand, one may have to compensate by paying a higher rate of interest due to their risky nature. Also important is to read the terms and conditions of the loan agreement carefully before signing on the dotted line. Many websites offer an online comparison of interest rates helping customers take the right decision. It is a smart choice to use these tools to one’s benefit. 

Note : This post is contributed by PaisaBazaar.

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