What is Personal Loan? Types, Features & Benefits

Sometimes, situations arise when a little more money would have solved our problems. It can be about buying consumer durables, house repairs, kids’ school admission, medical emergencies, or planning a vacation. Personal loans can be a great savior for financial freedom in such situations.

This article discusses everything you must know about personal loan meaning, how do personal loans work, and how to choose the right type of personal loan for your needs. Stay with us.

Definition of a personal loan

A personal loan is a financial lending instrument designed to provide quick access to money in the time of an emergency or financial distress. In such formally designed financial instruments, a financial institution, like a bank, can lend money quickly to individuals at pre-specified repayment terms and interest rates.

How many types of personal loans are available?

In India, personal loans can be of different types depending on the purpose of the money, eligibility criteria, and size of the loan. Some of the popular personal loans are:

Instant personal loan
Small personal loan
Medical emergency loan
High education loan
Home renovation loan
Wedding loan
Premium personal loans

Instant personal loans are lending instruments that require minimum documentation and minimum processing time, leading to nearly instant access to money. However, instant loans usually come with shorter repayment periods.

Small personal loans or micro loans are specialised lending instruments suitable for low-amount borrowing, sometimes as small as a few thousands. Design of standard personal loans may not be suitable to cater to such needs because of loan securitisation issues and other factors.

Medical emergency loans are suitable for meeting cash needs for hospital bill payments, surgical procedures, or other medical interventions. Lack of sufficient medical insurance among Indians and increasing medical costs have popularised such loans. Banks and non-banking financial corporations (NBFC) offer such loans in collaboration with large private hospitals and hospital chains. Individuals can directly apply to banks for medical loans as well with necessary documentation.

High education loans and standard education loans may not be similar. The former is suitable for financing short duration professional development courses while the latter is usually approved for degree programs from approved universities and colleges. Unlike standard education loans, high education personal loans come with shorter repayment periods.

Home renovation loan is one of the most popular personal loans in India. It can help gather funds for regular home repairs, painting, wall putty, fencing or other similar requirements. Unlike home building loans that require heavy documentation, engineer-approved estimation and release of funds in trenches, home renovation loans are simpler in processing.

Wedding loans or marriage loans are for meeting cash expenses to organise wedding ceremonies. Indian weddings are expensive and people often spend multiple times of their annual income on weddings due to maintaining social status or family values. Besides, expenses may also get inflated because of unforeseeable reasons. Wedding loans can save personal reputation without requiring to sell off assets.

Premium personal loans are categorised based on the size of the borrowed amount, just like micro personal loans. Such loan products are suitable when your monetary needs run in lakhs and crores of rupees at a very competitive rate of interests.

Features and characteristics of a personal loan

Some of the unique characteristics of personal products are:

Zero collateral requirement
benchmark-linked interest rates
Flexible repayment terms
Less documentation and faster processing

Zero collateral requirement – Almost every personal loan is unsecured, which means you do not need to mortgage any security to the lending bank or NBFC for getting such loans. Banks and NBFCs approve personal loans based on your creditworthiness rating, like the CIBIL score. And if you maintain deposits or other assets with a bank, you can demand a lower rate of interests on your personal loan.

Benchmark-linked interest rates – Unlike borrowing money from private lenders, personal loans from RBI-approved banks and NBFCs are always linked to benchmark prime lending rates. It helps to have a fair amount of visibility of the cost of borrowing through personal loan.

Flexible repayment terms – This is another unique feature of unsecured personal loan, as you may part-pay the loan through lump sum deposits or decide to early prepay the loan before it is due. It makes personal loans suitable for meeting financial emergencies arising from delay in receiving business payments or similar reasons.

Less documentation and faster processing – Personal loans are unsecured by design, which means banks and NBFCs approve loans without strictly verifying and validating borrowers’ source of income, assets and repayment capabilities. Usually, they check CIBIL scores and past loan payment experience. It helps keep documentation for personal loans simpler and processing faster.

Benefits of personal loans

Easy access to emergency funds – Personal loans are undisputedly the most easy to access loan products for meeting financial emergencies or shortage in cash flows. All other avenues of borrowing or collecting funds are expensive and time consuming.
Improved creditworthiness score – Taking personal loan and repaying the loan as per the terms actually improves a borrower’s creditworthiness score. It further reduces the cost of taking future personal loans.
Cheaper than using credit cards – Many people use their credit cards limits to borrow money or make payments instead of taking personal loans. But interest rates charged on credit card borrowing are always higher than personal loan rates. Besides, personal loans offer more flexibility as compared to credit cars.
Zero-obligation repayment – You may repay personal loans as soon as you have cash available to you, reducing the burden of interest costs. It makes personal a good cash management tool.

Disadvantages of personal loans

Hidden fees and strict penalties – Sometimes personal loans come with processing fees and heavy penalties for delay or, even, minor lapses in payment schedules. This may end up increasing the cost of borrowing.
Unnecessary borrowing or over-borrowing – Easy and faster approval may often lead to over-borrowing. This may lead people without a steady and secured source of income into a vicious cycle of debt trap and destroy financial stability in their lives.
Damage to creditworthiness score – Excessive amount of personal loan compared to your income capacity may negatively affect creditworthiness score. It ends up increasing the cost of future loans.

Conclusion

Financial emergencies are part of the fast modern urban lifestyle. Conventionally, in such situations, we rely on friends, families, unorganised private lenders or try selling family silver to gather a lump sum amount. However, these means can be time-consuming, unreliable, costly, and come at a risk of losing personal reputation. Comparatively, by personal loan definition and design, they are blessings for financial freedom. You just need to maintain a disciplined approach to borrowing and a healthy debt-to-income ratio.