There are a lot of misconceptions about personal loans that are floating around. For starters, people believe that personal loans are expensive and shouldn't be availed when it's possible to borrow money from friends and family. Others think that they are nothing but a Ponzi scheme run by the banks to take advantage of the common man. However, there is no truth to these statements. Personal loans are a great option to pick when you have to meet urgent cash requirements such as medical emergencies, home renovation, etc. They are completely safe and easily affordable too.
Divya is a very responsible adult who is in her mid-20s. Good job, dedication towards work, yearly appraisals have made her the perfect millennial! She took a personal loan for the interior that she wanted to do in her new house she just bought. The loan amount was 2,50,000. and the tenure she chose was 3 years. The first two years went well. She paid all the repayment EMIs on time, along with her regular expenditure and credit card bills. While she was turning 27, she got the biggest shock of her life. Her dad expired and being the only child in the family, there were many financial things that she had to take care of. First two-three months were okay. But then started the series of late payments and missed payments for her. As it was getting difficult for her to manage everything. Now this, led to a low cibil score for her.
After a few months, she thought of refinancing the previous loan and opt for a new personal loan to clear out the old debts. So that then, she will have the burden of only new loan that she had taken. When she went to banks, the major ones got rejected her loan application. When asking for the reason, she came to know that the poor handling of credits had led her to the bad score. Now, she thought if she could get a personal loan with low cibil score. There are many criteria which will be rechecked where banks or NBFCs or any financial institutions which may sanction the loan in such scenarios.
Your credit history plays the biggest role in the loan eligibility process. This is because it offers a deep insight into your creditworthiness, i.e. how good you are with credit repayment.
A bank learns about your credit history through a standard credit report which is offered by credit rating agencies. These include CIBIL, High Mark, Experian, etc.If you are interested in going through your credit history (which is strongly recommended for becoming "credit smart"), then you can apply for the report from any top credit rating agency by visiting their website and completing a simple process. In fact, for the first report, you don’t even have to pay anything as it's free as per the RBI regulations. The following are some of the most important components of your credit report that the creditors take into account:
1- Credit Score: Simply put, the credit score is a numerical representation of your creditworthiness. So, higher is the score, higher are your odds of getting a loan.
Credit History Age: If your credit history is decent and spans many years, then the lender won't have trouble taking confidence in you. This is because a long credit history serves as strong assurance. On the other hand, if your credit history is only a year or two old, then there isn’t much to establish a strong opinion with. Thus, the lender may feel reluctant to approve your HDFC personal loan.
Late Payments: Late EMI payments and credit card payments are extremely detrimental to your credit profile. So, if a lender sees a lot of these in your report, then they can easily reject your application.
Remember- it's rare to get personal loans without CIBIL check. So, be sure to monitor your CIBIL report regularly and take measures to keep the score high.
2. Income: If your credit profile appears trustworthy, then the next thing the bank wants to know is whether your income is high enough for you to repay the loan successfully. Basically, the creditor checks the nature of your income. If you a salaried professional, then they want to check whether you have switched jobs frequently in the recent past or you like to work in the same company for a long period. Similarly, if you are an entrepreneur, then they want to know what kind of business you are into and what your profits have been like in the past 3-4 years.
3. Outstanding Debt: Banks don’t approve personal loans without CIBIL check and income check. However, they also take into account your current outstanding debt if there is any. This is because even if you have a satisfactory credit repayment history and a stable income, you can't repay a loan if you are already in huge debt.
Rajiv Arora, like any other middle class Indian parent wanted to fulfil his child's career ambitions. Though he had saved enough in his 25 years of service in a private sector company it was not sufficient to fund a specialized course abroad. His child was looking for a global exposure and aspired to pursue his higher studies in the US.
Rajiv decided to take a personal loan to take care of the tuition fees and accommodation fees. He took an HDFC personal loan since he already had a saving account in that bank. It was the most convenient and less time consuming option. But soon the loan burden landed him in a financial difficulty. The EMI was beyond his capacity and the personal loan interest rate was way too high. What were the mistakes that Rajiv made ?
1. Not Knowing his Credit Score: Rajiv was clueless about what a credit score is and what role it plays in loan approvals. He never bothered to ensure that he had a healthy credit profile. Late payments on credit card bills and a high credit utilization ratio had resulted in a low CIBIL rating. Hence the bank charged him 22% rate of interest. If Rajiv knew the importance of a good CIBIL score, he could have planned well in advance. He could have taken measures to improve CIBIL score. By maintaining financial discipline and compiling a good record of on-time payments he could have qualified for a low interest personal loan and saved thousands of rupees.
2. Not Shopping Around: The most expensive mistake that Rajiv did was taking the first loan that was approved. He did not do an extensive research and comparison of various options to ensure that he gets a deal that is most viable. The interest rates on personal loans, terms, pre closure charges and fees varies greatly among different lenders. It always pays to look around at various alternatives and do an online comparison before rushing into signing the documents. Had Rajiv discussed with the financial experts and approached different sources of financing he could have landed a better deal.
3. Borrowing More Than The Repaying Capacity: Rajiv was happy that the personal loan eligibility criteria of the bank permitted him to borrow a sum of Rs 30 lakh that was needed to fund his education. But such a huge sum was beyond his affordability. Soon the EMIs overstretched his finances and led him into a crisis. He started defaulting on payment and his CIBIL score came tumbling down. Rajiv should have evaluated his financial condition and ensured that he had sufficient money to pay monthly EMIs as well manage his expenses before signing on the dotted line. After all a loan is a liability that has to be repaid along with a high interest amount in a timely fashion. He should not have borrowed the whole amount if he could not easily pay the monthly EMIs without straining his budget.
4. Not Exploring Alternate Options: Personal Loan interest rates are very high making this type of loan a very costly proposition. Rajiv should have explored for other options like loan against property, loan against securities, education loan or gold loan which have a significantly lower rate of interest. These alternate options would have been easier on his pocket. Personal loan should be opted only as a last resort when there is no other way out to meet emergency requirements.
5. Missing Payments: As with any other loan, a timely payment of the EMI of personal loan is imperative to maintain financial stability and keep the CIBIL score intact. Rajiv did not follow this ground rule and fell into a debt trap. Though taking a personal loan helped him meet his immediate requirement of funds, failing to service the debt properly caused his CIBIL score to plummet.
Avoiding certain pitfalls would have enabled Rajiv and Divya. In summary, one should look at the budget carefully before taking out a personal loan. Only if one can afford the monthly payments should one go ahead with the decision of taking a personal loan. Planning a little ahead of time and working to improve credit score can help one save thousands of rupees. Shopping around and comparing the deals offered by various lenders helps one to secure the best possible deal.