Personal Finance: Choosing the right kind of loan

Seeking a loan is not difficult. Taking the right loan, however, is what matters. Here’s a look at some of the different kinds of loans, and what you may need depending on your situation.

Seeking a loan is not difficult. Taking the right loan, however, is what matters. Here’s a look at some of the different kinds of loans, and what you may need depending on your situation.

For representational purpose only. (FILE)

Personal loans

Don’t fall for the myths surrounding personal loans. The truth is that these loans are unsecured, i.e., they do not necessitate any type of collateral. This means that banks do not rely on borrowers’ assets but approve loans based on their creditworthiness. These loans can be procured for a multitude of reasons including house renovation, wedding expenses, medical emergencies, paying to fix car damages, business expansion, refinancing home loans, education, and debt consolidation among a host of things. Easy EMI facilities coupled with less paperwork is a bonus. Less paperwork means that the bank does not seek any papers from you other than making you fill a form containing your details, the amount of loan asked and the purpose of the loan. However, these loans are costlier than home loans or car loans and are available in the range of 10.50-24% every year. Home loans are available in the range of 6.5-10% while car loans can be had at interest rates falling between 7% and 9%. Loan approval is quick and easy in these cases, so opt for it in case of financial immediacy.

Education loans

Education loans are equally unsecured but beget low-interest rates and may be a better idea if you indeed want to finance your education. The education loan can be taken for a full-time, part-time or vocational course only. Gaurav Aggarwal–Director & Head of Unsecured Loans, Paisabazaar.com, online virtual debt syndication services said, “Education loans charge lower interest rates in the range of 6-15.20% and offer longer repayment tenure than personal loans. Banks also offer a moratorium period on education loans for up to one year after course completion during which the loan accrues interest on a simple interest basis. Interest paid on education loans availed from banks and other institutions qualify for tax deduction under Section 80E.”

Financing homes

Seeking home loans against your property are common. But, what if you have bought property on power of attorney (POA)? Are you still eligible for home loans from banks or NBFCs? Most banks avoid giving home loans to secure properties bought on POA as the law does not grant ownership title to the buyer. Many NBFCs are also wary of giving home loans in such cases. Adhil Shetty, CEO, BankBazaar, an online market place for financial products said, “If the property involves a POA, then you may need to opt for a vanilla personal loan or use some other collateral acceptable to the bank, as most banks may not be willing to accept property involving POA as a security for the loan.”

Did you know that there is also something called a home improvement loan? If you need finances to refurbish or upgrade your home, opt for that. A home loan is restricted to the purchase of a constructed or under-construction property or the extension of the property. Compared to this, a home improvement loan is secured to renovate the structure without altering its basic structure. You can seek this kind of loan to fund renovation activities including tiling, flooring, internal/external plaster and painting, etc.

Different types of loans also have varying loan terms, interest rates, EMI facilities, and time limits. Let’s also acquaint ourselves with these various aspects of a loan.

Loan tenure

Short-term loans availed to support a temporary purpose can be availed for a period between six and 18 months. Loans taken for tenure not less than three years and secured to meet prolonged expenses are called long-term loans. Short-term loans beget higher interest rates compared to long-term loans. This prompts people to repay loans over a long tenure not realizing the added financial outgo despite the limited interest rates involved. However, you must choose a short tenure loan provided it does not stretch you financially every month.

Annual Percentage Rates

Many people compare loan interest rates to determine which loan is cheaper. However, more than just the basic interest rate charged on loans, a borrower must find out the annual percentage rate (APR) of the loan sought. APR is the real cost of the loan, which includes the interest rate, processing fee, origination cost (also called loan application fees), etc. You can calculate the APR using the formula [{(Fees + Interest)/ Principal}/ n] × 365 × 100. Thus, APR is almost always higher than the interest rate.

If you are unable to find out, ask the lender to share the APR to compare loans applied in other banks. Banks provide the APR on the loan when asked, thus, saving you the time to evaluate the same.

However, some bank loans are available on floating interest rates. Before choosing to pay at floating interest rates instead of the fixed interest method, you must be mentally prepared for the sudden variations in interest amount over the loan tenure due to fluctuating interest rates. Floating interest rates are subject to revision every quarter. You must opt for a floating interest rate when there is a likelihood of falling interest rates in near future. Besides, lenders do not charge a penalty on prepayment of loans taken at floating interest rates.

Total amount owed

Checking the total amount owed is another way to find if you have chosen the right kind of loan. This is equal to the total loan amount plus interest and fee charges. Irrespective of loans taken at fixed or floating interest rates, the total amount you owe is the amount that you are likely to pay altogether. If the monthly loan instalments do not stretch you financially, try and go for the loan with the least amount owed over the tenure subject.

Personal Finance is a weekly feature that aims to provide our readers pertinent and helpful financial information.