One cannot overlook the fact that loans have become crucial to our personal and business growth. When we need cash to tackle an emergency, a loan comes to our rescue. If truth be told, a Personal loan is a common way for individuals to obtain money to meet their household requirements. Whether you are planning a wedding, revamping your home, or managing medical bills, loans provide necessary financial assistance.
Before you take that leap, you must understand the loans as we discuss different types of loans. This blog elaborates on the basics, how they impact your credit score, and what credit costs signify.
What is a Loan?
A loan is a sum of money an individual or organization borrows from a lending agency or financial institution, including a bank or NBFC (short for Non-Banking Financial Company). A borrower agrees to repay over a specified period with interest. Loans are categorized based on the collateral requirement, purpose, and repayment terms.
Â
When an individual secures a loan for any reason, the lending agency or financial institution expects the borrower to repay the amount with interest. The amount borrowed is called the principal and the interest is the price paid to borrow money. Loans must be cleared within a certain period, which is called the loan term.Â
Types of Loans
- Short Term Loan
- Long Term Loan
What is a Short-Term Loan?
A short-term loan is primarily a loan that has a brief repayment period. These loans typically have terms ranging from a couple of months to a few years.Â
Individuals can secure a Short-term Personal loan for instant financial needs or when they are looking to settle their debt rapidly. These loans come with a shorter repayment period; thus, you would pay lower total interest. However, you must not forget that your monthly payment will be higher than a long-term loan.
What is a Long-Term Loan?
A long-term loan offers an extended repayment and may continue for many years. Individuals often prefer obtaining this type of unsecured loan when they want to make crucial investments, such as a home or a business.Â
With a long-term loan, you will have to make lower payments every month. However, there is a drawback to securing a long-term loan. You would pay more interest over the life of this loan because of the extended repayment period.
Benefits of a Personal Loan
A bank or an NBFC (Non-Banking Financial Company) grants this loan to an individual to meet their diverse personal needs. Listed below are some of the most significant benefits of securing a personal loan:
Â
Flexibility: One of the great benefits of using a personal loan is the flexibility. Dissimilar to a car or home loan, an individual can use this financial resource for personal needs.Â
To put it another way, the amount you borrow from a bank or an NBFC can be used to finance higher education abroad, your dream destination for traveling, and a wedding. You can also purchase the electronic gadgets or jewelry you have been eyeing. A personal loan is a simple way to help tackle that unwanted financial crunch.
Â
Minimal Documentation: You need fewer documents to seek approval on a personal loan. This is because it expedites the process. You must upload scanned documents for verification and will be granted the loan sooner than you think. This makes it a seamless and stress-free process.
Â
Quick Disbursal: Pre-approval of a personal is generally fast. Meeting the eligibility requirement plays a crucial role in granting a personal loan to an individual. Even having an ideal credit score is a great advantage. The time for disbursing a loan amount usually depends on the bank, lending agency, or financial institution, but it’s usually done within a day i.e., 24 hours. It could be as much as 72 hours. This makes it a favorable situation in an emergency.Â
Â
No Collateral Needed: If you qualify and meet the eligibility requirements for a personal loan, there is no need to present any collateral. Hence, your assets remain secure. And a definite advantage is if you do not own any assets. Since a personal loan is unsecured, it is considered the right way to seek financial support.
Â
Attractive Interest Rates: Expect an attractive interest rate when you apply for a personal loan, making it effortlessly reasonable for all. This ensures no change in what EMI you need to pay for your loan’s entire tenure.
Understanding Credit Score
A credit score is a 3-digit number, usually between 300 and 850, representing your financial trustworthiness. It signifies your credit standing or the possibility you will make timely payments of your bills. When deciding whether or not to approve your loan, lending agencies and creditors consider your credit score one of the most crucial factors.Â
What is Considered an Ideal Credit Score?
A credit score range and what it means will differ based on the scoring model used to calculate it. However, it is usually similar to the ones mentioned below:
Credit Score Range Rating 300–579 Poor 580–669 Fair 670–739 Good 740–799 Very Good 800–850 Excellent
You need to know that there is no magic number, which ensures a credit score will offer a specific interest rate from a lending agency or new credit account. However, a higher score usually suggests you have displayed responsible credit behavior earlier. It may give potential lending agencies or creditors more confidence when assessing a new credit request.
What is a Credit Cost?
Credit cost is one of the most vital factors affecting a lending business’s profitability. It refers to the money a lending agency or financial institution loses when a borrower defaults on a loan payment. These costs can be expressed as a percentage of the total loan portfolio. In other words, credit cost refers to the total expense when an individual borrows a certain amount. It includes the following:
- Interest Rate: The amount of borrowing’s annual cost
- Processing Fees: Charges taken by a lender for loan documentation and disbursal
- Penalties: For missed EMIs, prepayments, or foreclosure
- Insurance or Add-ons: Optional but it is sometimes included in the loan package
Even if the interest rate appears low to you, don’t forget that hidden charges and penalties can increase the rate of a personal loan. This is why you must know the complete credit cost before you secure any loan.
How Do Loans Affect Your Credit Score?
- Timely Repayment Improves Your Score: When you pay timely EMIs, it leads to financial discipline. It shows lending agencies or financial institutions you are trustworthy. Hence, it boosts your credit score.
- Loan Enquiries Impact Score: Every time you apply for a loan, the lending agency makes a hard inquiry into your credit report. Too many of these reports can harm your credit score.
- Defaulting Affects the Score Negatively: Missing or defaulting on loan payments can significantly drop your credit score.
- Credit Mix Counts: If you have a mix of secured and unsecured loans, it can have a positive impact on your credit score. This shows you can easily manage different types of debt.
Â
How Do Loan Terms Affect the Cost of Credit?
Loan terms, such as tenure, interest rate, and repayment schedule, can affect how much you pay over time.
- Higher Interest Rates Lead to a Higher Cost: This is no no-brainer! If the interest rate is high, you eventually pay more over the tenure.
- Long Tenure Leads to More Interest: While a longer tenure can help you manage your EMIs, it increases the total interest you end up paying.
- Prepayment Penalties: Some lending agencies or financial institutions charge fees if you settle your loan in advance. Therefore, ensure you check the fine print before committing anything.
- Credit Score-Based Pricing: Some lending agencies offer reduced interest rates to borrowers with excellent credit scores. For instance, a score of over 750 might help you secure a personal loan at 10%. A lower score, on the other hand, might come with a 16% interest rate.
Â
Tips to Manage Personal Loans and Credit Costs
- Borrow Only What You Need:- Avoid getting tempted by taking a high amount because you meet eligibility criteria.
- Compare Interest Rates and Charges:- Consider using tools available online to compare personal loan offers from various lenders.
- Make Timely Repayments:- Activate EMI auto-pay if possible! This way you will avoid penalties and damage to your credit score.
- Track Your Credit Report:- Ensure you track your credit report regularly. Doing so will help ensure accuracy and keep you updated on your credit standing.
Final Thoughts
A personal loan can be an effective and powerful tool for achieving life goals. However, it is important to comprehend how it affects your credit score and the credit cost. Smart borrowers not only care about the EMI. They assess interest rates and hidden charges. When you plan to secure a personal loan, ensure you make timely repayments. Doing so will improve your credit score.
Frequently Asked Questions
Disclaimers
The information provided in this blog is for informational purposes only and should not be considered financial or legal advice. Loan terms, interest rates, and eligibility criteria may vary based on the lender’s policies. Readers are advised to verify details with financial institutions before making any decisions. We do not guarantee loan approval or endorse any specific lender.
