A personal loan is an unsecured loan, typically with a tenure of 1-5 years. These are given without guarantors, asset hypothecation or collateral, and have a variety of potential lenders ranging from banks and NBFCs to P2P lending platforms. Loan amounts tend to be capped due to the lack of asset collateral.
Personal loans are generally used for one-time expenditures like weddings, travel and rental deposits. Additionally, they can be used to consolidate or repay high-cost debt, fund medical emergencies and business investments. Given their flexibility, processing time and effort, they make for attractive loan options at short notice. The interest rate on these loans are higher than comparable secured loans like home loans or LAP.
There are 4 big factors that banks typically focus on. First, your place of employment tends to be categorized into 3 tranches, A, B or C. If, say, you work at a reputed multinational company, your eligibility is likely to be rated high. Second, your liabilities and obligations count as a risk for banks. If your total EMI obligation on existing loans, like a home loan, exceed 50-75% of your net salary, a lender will not be willing to underwrite an additional liability. Third, your gross and net salary determines your capacity to repay and therefore has a disproportionate impact on both your eligibility as well as your interest rate.
Finally, your credit score is the primary check that banks use to ascertain your creditworthiness. A credit score below 600 automatically raises red flags, reduces the number of lenders willing to take on your case, and increases the interest rate of your loan as a risk premium for lenders.
If you are applying for a personal loan, then your application must follow a few standard protocols. They are eligibility checks, credit score checks, documentation, verification, approval, and disbursement. Every lender has their own time frame that they take to approve a personal loan. After submitting your application along with your documents, it might take as many as 7 days to get your loan approval and a couple of days more for disbursement.
mymoneykarma makes this process easier than ever. From checking the eligibility to making sure the disbursement is done correctly, everything is taken care of by the executives. You just have to fill out the application form and upload your documents to the website. You will get your loan approval in less than an hour.
Your personal loan EMI, or equated monthly installment, is calculated using two parts, an interest payment and a part payment of your principal. You only pay interest on your outstanding balance. So this means that even though you pay the same EMI each month, it comprises an increasingly larger proportion of interest repayment and decreasing amount of interest. This ensures that by the end of your tenure, you have completely paid off your loan and have zero outstanding balance on your loan amount.
To understand your EMI calculation, and to run various scenarios on your interest rate, loan amount, and tenure to select the option that saves you the most money, make sure you use an EMI calculator like the one here https://www.mymoneykarma.com/personal-loan-emi-calculator.html
Answers to these questions tend to be needlessly complex, when there is only one metric you need to optimize: the present value of all your interest payments, that is, the time-discounted value of your total interest payment. To explain this, let’s take 3 simple cases. First, if you suddenly have excess liquidity or capital on your hands, and your alternate investment opportunities yield low returns, then you should consider a pre-payment of your loan to reduce your outstanding principal. If your personal loan interest rate is high, you should additionally reduce the tenure of your loan.
These 2 actions will reduce the total interest payments you will make and save you a lot of money. Second, if your cash flows have increased, perhaps through a salary raise, and your personal loan interest rate is higher than market returns, then you would save money by channeling your cash flows into paying off your loan faster through higher EMIs over a reduced tenure. If market returns are higher than your personal loan interest rate, then you would make more money by instead investing your increased cash flow through SIPs. Third, if the personal loan interest rates in the market fall, then you would save a lot of money by refinancing your loan and doing a balance transfer of your outstanding principal amount.