Whether you are looking for some finances to fund your child’s dream wedding, or renovating your home and turning it into a fancier-looking place, or taking that vacation you have been meaning to take for a while now, personal loans are great solutions as they give you instant access to funds. However, there are misconceptions about personal loans. A lot of people tend to think that they are not good for you as they could put you in debt. While that reasoning is not entirely wrong, it all comes down to how you manage your finances.
Personal loans are great solutions for paying off medical bills, home and car repairs, school or college-related expenses, etc. However, it is advised that you only take a personal loan if you find yourself in an emergency and have no other means to avail finances. There are a few important factors that you must keep in mind before applying for a personal loan. They are as follows:
- Credit History Affects Personal Loans and Vice-Versa
Your credit history is basically an indicator for a lender to assess your ability to repay the loan. If you avail a personal loan, your repayment of the loan in Equated Monthly Instalments (EMIs) will have an effect on your credit history. That is, if you repay your EMIs on time each month, it will reflect well on your credit behaviour, thereby positively affecting your credit score. In case you default on EMI payments, your credit score will be affected negatively. When you approach a bank or financial institution for a personal loan, they check your credit score to determine your eligibility for the amount you wish to borrow. A lower credit score will not only increase the interest rate for a personal loan but also has the potential to see your application rejected altogether, thereby making it essential to maintain a healthy credit score.
- Income and Employment Determine Your Eligibility for Personal Loans
Almost all banks that offer personal loan have minimum income criteria and loans are only offered to individuals if they earn over a certain amount each month, check more details here. Lenders basically want to know if you have a source of steady income with which you can repay the amount you borrow from them. It is for this reason that borrowers are asked to submit their pay slips and proof of employment when applying for a personal loan.
Self-employed individuals, on the other hand, also need to show proof of income to the lender when applying for a personal loan. The number of years spent in an organisation as an employee is also very important when availing a personal loan as it convinces the bank that you are a less-risky customer. The income you earn will determine how much money you can borrow from a bank. The higher your income, the higher the amount you can borrow and vice-versa.
- Your Outstanding Debt Will Determine the Quantum of Loan
Banks and financial institutions lend you money on the condition that you will pay them back. As such, they carry out eligibility checks to verify if you are a trustworthy customer, and only lend you an amount they believe you can repay. Having other debts, such as credit card debt, in addition to a personal loan, will lower your disposable income, thereby making it hard for you to make ends meet without sinking in debt. Your debt-to-income ratio is essentially the parameter that measures your ability to repay your debt with the income you earn. Banks check this factor when you apply for a loan, and your application could be approved or declined based on how high or low your debt-to-income ratio is.
- Personal Loans can be used for Debt Consolidation
- Debt consolidation refers to availing a new loan to clear off your consumer debts and liabilities. Basically, if you have multiple outstanding debts, you can take a personal loan to pay them off and have only one outstanding debt instead of multiple debts. The benefit of doing this is that the interest rate applicable to the personal loan will be relatively lower in comparison with the other debts. Furthermore, you will not have to worry about repaying various loans and credit card bills on different dates each month, thereby not only easing your debt but also lowering the stress associated with debt.
- Personal Loans will Attract New Credit Enquiries
- With every personal loan application you draft and submit, the lender carries out a hard check on your credit score to see if you will make for a trustworthy customer. This essentially means that a full copy of your credit report will be pulled out to determine your eligibility for the loan. It is a standard procedure that all banks engage in when you apply for personal loans, car loans, or home loans. The disadvantage of this is that credit inquiries tend to lower your credit score, albeit marginally.
- The higher the number of loan applications you submit, the higher will be the number of times your credit report is pulled up. Although the effect of this remains only for a year or so, it could seriously hamper your chances to getting a personal loan at favourable terms. To avoid this, you need to check your eligibility for loans with different banks and submit your application only once you have narrowed your options down to one or two banks.
Although personal loans can be a boon to many, they do have their downsides. It is very important to assess your financial standing before taking a personal loan. It is advised that you only avail one if you have literally no other source of funds. Even when you take a personal loan, be sure that you have the resources to repay it in a timely manner as failure to do so will not only affect your credit score but also weigh you down in debt. Do your homework and compare top banks in India to find the personal loan that will best suit your financial requirements. Considering the interest rate, the processing fees, the tenure of the loan, etc. can go a long way towards ensuring that you get the most out of your personal loan.