11 Apr 2014

Rupeepower Editorial Team

Cost-Benefit Analysis of Personal Loans

Of late personal loans have become an inevitable resort to fund a number of our growing demands/needs/wants. Howsoever much experts may trash personal loans for the obvious reason that they are expensive but more often than not these are useful in specific circumstances (financial emergencies or contingency requirements like medical, marriage, family function, education, vacations, travel, home purchase, improvements, etc) and if smartly used can enhance a household’s asset base and wealth. The overruling fact however remains that more often than not many of us consider personal loans as the best option for meeting our contingencies without even going through the terms and conditions of the loan document. It is thus important before opting for a personal loan, one must be aware of the method of calculation of the interest rate. Personal loans usually come with a flat rate, a reducing balance or advance EMI (normally used for consumer durable loans).and it is necessary to compare other options (interest rates) available. In the case of a flat rate, one is charged a simple interest rate ( eg for a personal loan f Rs 2 lacs @15% one will have to pay a yearly amount of Rs.30,000). In the case of reducing balance the EMI and the interest rate computation are equated in EMI’s over the spread of the loan period and the interest is charged on the balance outstanding. As far as advance EMI is concerned the lender (bank or NBFC) usually takes 2/3 EMIs in advance thereby reducing the principal amount, but interest is charged on the entire amount instead of the reduced amount. Hence it is important to do a cost benefit analysis in terms of weighing the various options available and hence a better judgment.

Banks and non banking financial companies provide personal loans and there are a number of eligibility factors that determine whether or not an individual can get personal loan from either a bank or a NBFC. The factors amongst other include, financial background, credit history, company where the individual is employed, any other loan that the individual may have availed. The most important criterion is obviously the financial background as it helps in determining both the eligibility and the quantam of the loan that can be given to the individual. This helps the bank analyse whether the individual can repay the loan or not. (The minimum income level criterion is different for different banks). A good credit history (if any) helps the bank ascertain the track record in terms of payments of EMI or credit card bills. A good credit history maximizes the chance of the individual getting the personal loan. The eligibility at many a times depends on the company where the individual is working (the banks have a classification of companies eg. A Class, B Class etc). If an individual works for an A class company the chances that he can avail the personal loan at a lower rate is higher than that of an individual working for a B class company. Further if an individual is already availing a different loan at that point in time, the eligibility of personal loan decreases as the income at hand is lower ( due to the payment of EMI of the previous loan)

At times an individual can opt or a loan against property ( ie a loan disbursed by the bank against the mortgage of the property ).

Loan Against Property
Personal Loan
The individual takes the loan by mortgaging the house property An individual can take a personal loan for personal use without any security or guarantor
One of the cheapest retail loans after home loans; usually about 12%-16% Higher interest rates compared to LAP; usually issued at interest rates in the range of 16%-21%
Since the rate of interest is lower, frequently LAP Equated Monthly Installments (EMI) turn out cheaper Since rate of interest is high, Equated Monthly Installments (EMI) for personal loans are high
Maximum loan eligibility is determined primarily by the value of the property and income Maximum loan eligibility is determined primarily by an individual’s income
Maximum loan tenure for LAP is up to 15 years (180 months) Maximum loan tenure for personal loan is up to 5 years (60 months)
Secured loan
Unsecured loan

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