Imagine how great it would be if you never run out of money in any situation. Tough to imagine, right? Because in reality, it’s a constant struggle to make ends meet.
Sometimes you overspend and sometimes your income is just not enough to cover your requirements. No matter what the situation, financial crunch can be really stressful.
It’s for such situations that personal loans were designed. Need a few hundred dollars for a medical emergency and at least 2 years to return that amount in fixed monthly instalments? A personal loan can help. Need a constant financial backup that allows you to borrow repeatedly and at any time? A personal line of credit can help.
It’s alright if you are new to the world of personal loans and don’t understand how it works. This is a complete guide for you to understand what personal loans are and how you can use one in any situation.
First Things First: What is a Personal Loan?
It’s an unsecured loan that allows you to borrow an amount for a certain, predetermined period at a fixed rate of interest. Unsecured loans are different from secured loans in the sense that you don’t have to provide any asset of yours as collateral (like your house or car), for the former. However, for the same reason, unsecured loans tend to be a little costlier than secured loans.
For instance, if you compare a home loan with a personal loan, you will find that the former is cheaper than the latter. That’s because home loans are secured by the same property you bought with the loan. On the other hand, personal loans are not secured, therefore, costlier.
Pros and Cons of Personal Loans
Unsecured: You don’t have to pledge any asset as collateral for the loan. This means if you default, the lender cannot take possession of any of your personal belongings.
Quick approval: Lenders generally promise to approve the personal loan within a day if you meet the eligibility criteria and if you submit all necessary documents in time.
Flexibility to choose tenure: You can choose a tenure that fits your need. The longer the tenure, the lower will be your monthly repayments.
Higher interest: Since these are unsecured loans, the interest charges are usually higher than secured loans.
Credit history: Lenders always run a credit check before approving a personal loan. So if you are someone with a poor credit history or no credit history, it may get a little difficult for you to secure the loan. But if you have a good credit score, then this could a pro for you.
How Do These Loans Work?
When the loan is approved, the lender will credit the whole amount (after deducting the processing fee) to your account that you can use as per your requirement. If it’s a personal instalment loan, there will be fixed interest rate and fixed monthly repayments throughout the tenure of the loan.
What Can You Use a Personal Loan For?
As the name suggests, a personal loan can be used for any personal purpose. You don’t have to specify a reason while applying for a personal loan. Once approved, you will get a lump sum amount that can be used at your discretion. You could use for a vacation or to pay off a medical bill.
That said, it’s best to avoid taking a personal loan for gambling, or to invest in stock markets. There can be serious consequences if you fail to repay the loan, which we will discuss later. But, first, let’s understand the different types of personal loans.
Types of Personal Loans
Personal Instalment Loan
It’s a type of personal loan where you can borrow any sum, up to a limit, at a fixed rate of interest. You get the flexibility to choose a tenure that best serves your purpose. Although there is no rule on choosing the right tenure, it’s generally considered best to keep the tenure as short as possible.
Throughout the tenure that you choose, you will have to pay a fixed payment every month to the lender. This monthly payment would consist of the principal amount as well the interest amount.
For instance, assume that you take a personal instalment loan of $48,000 for a period of 12 months at 6% p.a. So your monthly payment would be S$4,240 calculated as: $4,000 ($48,000/12) + $240 (6% of $48,000/12). This example is for illustration purpose only. Actual calculations will differ from bank to bank.
Personal Line of Credit
Personal line of credit is an unsecured revolving credit facility that is offered against your credit card balance and based on your monthly income. You get access to a certain credit limit; you don’t have to withdraw the whole amount immediately. You can withdraw any amount as and when required. Also, you pay interest only on the amount you actually withdraw.
When it comes to repayment, a personal line of credit doesn’t require you to make fixed monthly payments. Like credit cards, you can pay the minimum due amount or any other amount.
This type of personal loan is generally preferred when your loan requirement is not fixed and when you may need additional funds from time to time.
For instance, if you are a variable income earning individual, you could use this facility to cover your expenses when your income is not enough for a particular month.
Remember, this facility may involve an annual fee that you will have to pay regardless of your usage of the funds.
If you are someone struggling to deal with your credit card debts, this option could be ideal for you. With a balance transfer loan, you can transfer all your credit card outstanding loans to one account that offers a lower fee and interest rates. It’s like refinancing your credit card debts.
In Singapore, balance transfer loans are usually offered for a tenure of up to 12 months. You will have to pay a minimum amount each month while any remaining balance will have to be repaid during the last month.
Some banks also offer a grace period wherein you will not be charged any interest on the amount of the loan. However, there could be a one-time processing fee. So if you manage to settle your dues within the grace period, your cost of borrowing would be just the processing fee.
Debt Consolidation Plan
It’s a type of personal loan that has been designed to allow you to consolidate all your unsecured outstanding balances to a single loan at low interest rate. The unsecured debts could include your credit card dues as well as personal loans. Certain loans like home renovation loans, education loans, and business credit facilities are generally excluded from this plan.
Once your debt consolidation (DCP) plan is approved, the lender will directly settle all your outstanding balances with other lenders. With DCP in place, you will have to manage only one loan instead of managing multiple loans. The DCP loan amount is repaid in fixed monthly instalments that are determined on the basis of the amount and tenure of the loan.
However, note that a debt consolidation plan is usually considered as a last resort for settling your unsecured debt and will remain on your credit report for 3 years after the termination of your loan.
Things to Consider Before Taking a Personal Loan
Can You Afford the Loan?
It may be easy to get your loan approved, but it’s really important to consider whether you can afford the loan. If you can’t afford to pay it back, don’t borrow or extend your tenure because the longer the tenure, the lower the monthly payments. However, remember that longer tenure means higher interest payments.
How Much Do You Actually Need to Borrow?
You may feel tempted to borrow a bigger amount just because the bank says you’re eligible for it, but it can put you in financial stress. Figure out how much you actually need and stick to that amount. This also means that you should never borrow to splurge. Borrow only when there is an emergency.
Is There Any Cheaper Option Available?
Before you sign up for a personal loan, see if there are any cheaper options available. For instance, if you want to remodel your home, it’s better to opt for a home renovation loan that is cheaper than personal loans.
What’s Your Credit Score?
When it comes to personal loans, your credit score matters. It’s this score that banks use to determine your creditworthiness, especially in case of an unsecured loan. This score reflects how you have managed your loans in the past and determines your risk of defaulting on the loan. The higher the score, better the chances of your loan getting approved.