5 most common personal loan myths—What you should really know | Mint

Whether an individual has a medical emergency or wants to enjoy a leisurely family vacation, a personal loan can provide the required funding. While applying for a personal loan, you don’t need to tell the financial institution about the end use of the money.

Also, with the increasing digitisation adoption, these days, personal loans are approved and disbursed quickly. These factors make personal loans a go-to option whenever an individual needs funds. Inspite of these features and benefits, there are many myths surrounding personal loans.

These myths make people wary of applying for them. In this article, we will discuss some common myths about personal loans.

They are meant only for medical emergencies

One of the biggest myths about personal loans is that these loans are meant only for medical emergencies or other emergencies. While personal loans can be used for medical emergencies or other emergencies, that is not the only use. Personal loans can be used for various purposes like debt consolidation, home renovation, marriage or any other functions, family vacation, buying a consumer durable, education expenses, buying a new or second-hand vehicle, starting a business, etc.

Infact, you don’t need to tell the bank or the NBFC about the end use of the personal loan. As long as the end use is for a genuine purpose and legal, you can use the personal loan amount for anything. Apart from emergencies, these days, many people take personal loans for planned activities like home renovation, education, family functions, etc.

A credit score of 750 or above is a must to get a personal loan

A common myth about personal loans is that an individual must have a credit score of 750 or above is a must to get a personal loan. A credit score of 750 and above has certain benefits. For example, a higher credit score can help an individual negotiate with the bank for a lower interest rate, reduction/waiver of processing fee, higher loan amount, higher loan tenure, etc.

However, it doesn’t mean people with a credit score of less than 750 will not get a personal loan. While a credit score of 750 or above is ideal, many financial institutions give personal loans and other loans to individuals with a credit score of less than 750.

Many financial institutions consider a credit score in the 700 to 750 range also decent to approve a personal loan. Some financial institutions consider a credit score of less than 700 also for giving personal loans provided the other factors are in favour. These include the applicant having a stable income source, steady career, no loan/credit card defaults in the past, lower debt-to-income ratio, availability of a co-applicant or guarantor, etc.

It is important to note that a decent to good credit score is only one of the factors considered when evaluating personal loan applications. Even if the credit score is slightly lower than required, and all other factors are strongly in favour, the financial institution considers it. Some financial institutions may charge a higher interest rate or reduce the loan amount to compensate for the higher risk due to a lower credit score.

Personal loans are given to salaried people only

Salaried people have a fixed and regular monthly cash inflow. It helps financial institutions evaluate the personal loan application with some degree of certainty. However, that doesn’t mean personal loans are given to salaried people only.

Financial institutions process personal loan applications from salaried, self-employed, professionals, consultants, business people, etc. In the case of non-salaried people, the monthly cash flows are usually uneven. Hence, financial institutions evaluate their personal loan applications in more detail. In cases where non-salaried applicants have a good credit score, low debt-to-income ratio, regular cash inflow, etc., the personal loan application processing can be as smooth and quick as in the case of salaried people.

The interest rate on personal loans is high

Personal loans are unsecured loans, i.e. without any collateral or security. Hence, the interest rate on personal loans is higher than secured loans as they carry higher risks compared to secured loans. Comparing personal loan interest rates with those of secured loans like home loans, vehicle loans, etc., is not a fair comparison. However, when we compare to other unsecured loans like credit cards that charge 36% to 45% per annum, personal loan interest rates are far lower.

The interest rate on personal loans depends on several factors. Some of these include the interest rate regime in the economy, the individual’s credit score, the DTI ratio, the availability of a co-applicant/guarantor, the financial institution’s cost of funds, etc. In a high-interest rate regime like we currently are in, the interest rates on personal loans and all other loans are high. However, when market interest rates head lower, the interest rates on all loans, including personal loans, go down.

Currently, most banks and NBFCs charge interest rates in the 10% to 15% p.a. on personal loans. Before applying for a personal loan, compare the interest rates offered by various banks and NBFCs and choose one that suits your needs. You can use an aggregator website/app to compare interest rates.

A personal loan cannot be taken with an existing loan

Some people believe that a personal loan cannot be taken with an existing loan till it is fully repaid. The belief is completely untrue. You can take a personal loan with an existing loan, provided your finances allow it. When you make a personal loan application, the bank assesses your debt-to-income (DTI) ratio.

The DTI ratio measures the percentage of monthly income going towards repaying existing loans. Banks consider a DTI of 35% or below good for approving a loan application. Some banks consider a DTI in the range of 36% to 50% for approving loans on a case-to-case basis. In some cases, the bank may charge a higher interest rate, reduce the loan amount, or insist on a co-applicant/guarantor to mitigate the higher risk involved.

So, if your DTI ratio is within the bank’s prescribed limits, you can take a personal loan with an existing loan. There are many people who have taken a personal loan along with a home loan, vehicle loan, etc. as their finances allow it.

Stay clear of personal loan myths and use them with responsibility

Now that you are clear about the common personal loan myths, you can apply for it if you need it. You may get pre-approved personal loan offers from banks and NBFCs. However, you should apply for them only when you have a genuine need. Personal loans are one of the easiest and quickest loans to get. Hence, you should use them with responsibility. Otherwise, there is a risk of falling into a debt trap.

Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.