Choosing the best personal loan: Here's a borrower's checklist

Personal loans are affordable alternatives to credit cards for urgent cash needs. The rate of interest for personal loans starts from 10.25 percent a year, which is much lower than any other form of unsecured credit.

Due to the pandemic, in the last 17 months  unprecedented loss of business, jobs and financial disruptions have posed unparalleled demand for emergency loans. No wonder then that the RBI data revealed that at the end of financial year 20-21, gold loans outstanding jumped 86 percent. In June 2021, overall personal loans registered an accelerated growth of 11.9  percent.

Whether you are looking for a personal loan to tide over a medical emergency, or for home improvement, debt consolidation or other expenses, here is a checklist to help you navigate and make an informed credit decision.

Choose your lender wisely

The recent lockdowns pushed up digitisation and adoption of FinTech in the country. Lenders have updated their systems to offer seamless online loans without a human touch. As a results, customers today are overwhelmed with personal loan options available from not only high street banks & NBFCs they have known for years, but also from new age lending apps and Neobanks.

Even first time borrowers are able to qualify for unsecured loans on the basis of social credit rating systems. The omni-channel marketing approach of the digital lenders has further flooded customers with loan options.

How to choose the right lender? Never should you apply for the first offer available in your email, Whatsapp or SMS. Though it is flattering to get a desired personal loan offer from your own bank, chances are high that you are missing out the top offer or deal. Also, be mindful of instant loan offers from lending apps, which could come at a comparatively high rate of interest.

So, do conduct preliminary market research. It is literally effortless to compare available lowest rate personal loans with flexible terms using a loan aggregator website. You can choose a customised loan offer according to your needs. The preferred lender & offer would significantly vary according to the quantum & tenure of the loan. Go for a bank offer if you need a loan for 2-5 years while an instant app could be your undisputable ally for a 3 to 6 month funding backup.

Rate of interest

Be vary of the flat rate of interest marketed by the lenders. Flat rate makes the offer look attractive wherein you are paying more from your pocket for interest rate. It is always advisable to choose the loan offer where the rate of interest on EMIs is calculated on the reducing balance method. For instance, on Rs 5 lakh personal loan offer at 10 percent a year for five years, the total interest outgo will be Rs 1, 44, 668. The average interest outgo annually will be Rs 28933 i.e. flat annual rate of 5.80 percent. The offer appears amazingly attractive at flat rate.

EMI Calculation

It is important to internalize relevant financial jargon associated with the personal finance landscape. Think before signing up for a 0 percent EMI scheme. Mostly banks tie up with FMCG brands to offer 0 percent financial schemes online & offline. Before selecting such schemes, consider processing fee & file charges attached. Buying an air conditioner worth Rs 40,000 at 0 percent interest for six months and processing charge of Rs 2,000, you are not really buying at zero cost.

Another unexpected cost is a loan with Advance EMI option. You will end up paying way beyond the contracted rate. Paying 2 EMIs in advance for a short term loan of Rs 1 lakh for 18 months at 14 percent, translates to an interest cost of 17.5 percent.

Calculate other charges

It is customary to charge up to 1-2 percent processing fee on Personal Loans by lenders. Some banks have upfront administrative charges which are non-refundable and are to be paid along with the application. It is thus advisable to get a good fix on all applicable charges. Some of the common fees and charges include: processing fee, interest rates, foreclosure charges, penal charges etc.

Prepayment & foreclosure charge

RBI restricts banks from charging foreclosure fee on only floating interest rates loans. Personal Loans are offered on fixed rate of interest and are thus open for prepayment & foreclosure charges. In short term loans, the foreclosure charge is mostly waived off. While for regular car loans or personal loans a 4 percent foreclosure charge is levied on the prepaid amount. Thus, if you have plans to close the loan early, it is advisable to choose a lender that offers you maximum flexibility on repayments, partial or total.

Credit Score

Last but not the least, your repayment history and Credit score will always help you grab the best offer. A robust score above 800 makes you a credit worthy customer, eligible for the lowest rate. It is thus advisable to take care of your credit score at all times.

While shopping around for the best personal loan offer, be mindful to not approach multiple lenders simultaneously. Multiple personal loan queries with various lenders is viewed as credit hungry behaviour which can have a negative impact on your borrowing plans. Again a loan marketplace can help you compare available interest rate quotes from multiple lenders without compromising your credit score.

When you do your homework well, you would surely seal the best available deal.