Consumer (Personal) Loans

Introduction

Personal loans include various types of unsecured loans. They are provided largely on the basis of personal creditworthiness, but income and current levels of debt are also taken into account. These loans are cost-effective and involve less risk for the borrower. Most banks offer them. Personal loans can be taken for any reason. Some people use them to finance vacations, others to help pay larger bills. The loan is a lump sum which must be repaid with interest within a specified timeframe. The repayment schedule may be anything from months to years (normally up to 5 years).

Personal loans help individuals and businesses meet short and long-term objectives. They can be used to start a new business, but in such cases the individual remains personally liable for the borrowed funds, even if the business defaults.

Banks offer two kinds of consumer loans:

• non-earmarked loans (cash disbursed to the borrower)
• earmarked loans (non-cash loans, disbursed directly to the seller), specifically for:
  • a car purchase
  • education
  • land or housing, without mortgage
  • agriculture or other business purpose
  • consumer loans provided to customers through retailers and service providers

Benefits

Certain situations require immediate access to substantial amounts of cash to fund purchases. It may be an emergency or a hardship situation. After they have obtained the money, borrowers can repay the lender over time. This arrangement eases situations that create financial difficulties and allow purchases that exceed current savings.

Personal loans offer better interest rates than credit cards. In the long run, the client will spend significantly less money with a personal loan than by using a credit card.

How the application and approval process works

Personal loans are relatively easy to get. The client and cosignatories are normally only required to complete an application and provide statements of income.

Banks base their decisions to grant loans on a number of factors. In evaluating applicants, the loan committee may review income level, employment record and payment history for previous loans. The banks approve or deny the application on the basis of this information. Even if an application is denied, it may be possible to reapply later. Once an application is approved, the bank will determine the interest rate. In general, people considered to represent high credit risk are lent money at a higher interest rate than people considered low credit risk. A cosignatory (guarantor) shares responsibility for the total amount owed. If the borrower defaults on a loan, any cosignatories are equally liable and share responsible for repayments.

What types of security do banks ask for?

Banks normally ask for one or more of the following instruments as loan security:

• salary assignment by the borrower and for the guarantor (with a notarized undertaking by their bank, if not the same one), which allows automatic deduction of funds to an agreed level from their accounts in the case of default
• life insurance for the borrower in the bank's favor
• a promissory note signed by the borrower
• a dedicated deposit, if the loan is deposit-secured
• comprehensive car insurance in the bank's favor (for car loans)

What should a client know before signing a loan contract?

Prospective clients should analyze their loan contracts thoroughly and make sure they understand them before signing. Bank officers should answer all client questions clearly. The client should insist on all the clarification they find necessary and should not rush into signing. Taking a few hours or even days to consider a loan contract may prevent difficulties later on.

A client should be perfectly clear on the following:

• The total amount being borrowed. For many loans, the total amount equals the price of the goods or services minus a down-payment or advance payment. Where the loan is secured against a deposit, the amount is reduced by the funds on deposit.
• The kind of interest rate (fixed or variable) and its level and the frequency and number of installments. How much is the monthly installment? When are installments due and how many will there be? Some loans involve variable interest rates and a foreign exchange clause, while other loans may involve a very high final payment. The terms, rates and rules of calculation may vary significantly depending on the contract and the borrower should receive full clarification of all terms.
• Indexed loans (loans with a foreign exchange clause) have installments whose domestic currency value will vary, depending on the exchange rate. The borrower should understand how the bank applies exchange rates over time and the likely impact on installments.
• The total sum for repayment - the client should be clear as to the total amount to be repaid over the loan period to determine whether he can afford it (or rather the goods and services to be paid for using the loan). The total price is the sum of the installments, which simplifies comparison between different loan products.

Installment amount x Number of installments = Total installment amount

Total installment amount + Final installment (if applicable) + Loan costs + Down-payment = Total amount for goods/services

• Additional costs can be an important element in the loan contract and can play an important role in deciding on a loan. Some typical costs are:
  • the application fee
  • the management fee for collating the required documents
  • a late payment fee, where applicable
  • a prepayment fee for early repayment
  • a loan insurance fee, where required
• The effective interest rate (EKS) helps clients compared different loans, as it represents the full costs and all additional fees.
• The conditions under which the bank can activate the instruments securing the loan. If the borrower is late with payments, the bank may activate the instruments securing the loan. Borrowers should know when and how the bank can activate them. They must understand that any breach of the loan contract can impair future ability to borrow.

Information the borrower needs from the bank

• Whether there is a maximum age limit. Borrowers must be over 18 years of age, but there may also be an upper limit, usually related to the borrower's expected age at loan end.
• The installment amount is normally determined on the basis of total income (salary + other income). Banks generally prefer total monthly repayments (including all debts) not to exceed one third (sometimes one half) of monthly income.
• Whether the bank requires a down-payment and of what size (10, 20 or more percent). Down-payments reduce the sum being borrowed.
• If the loan is secured against a deposit, then the client should be clear on the interest rate applied to the deposit (banks normally pay very low interest rates of 1-2%). Potential interest foregone on the deposit should be considered an additional cost.
• Interest rates are sometimes given as monthly. The annual interest rate is not just the monthly interest rate multiplied by 12. For example, if the monthly interest is 1%, the annual interest rate is not 12%, but 12.87%.
• Loan repayment is normally through monthly installments consisting of repayments of the principal and interest payments. It is important to be clear on whether monthly installments are equal for the entire life of the loan.