The who,why, what and when of personal loans!

Rakesh Sinha is employed with Patni computers. His father, a retired government employee discusses a plan for buying a plot of land that looks promising in his hometown. The only set back for Rakesh’s father was that he was short of Rs. 3 L with the land costing around Rs. 10 L.  Rakesh told his dad to proceed with the purchase and promised to come up with the funds in a couple of days. Rakesh knew he could easily afford a personal loan of Rs.3L with his salary of Rs.8L per annum. He planned to repay the loan in a span of 3 years with an EMI of around Rs.10, 200. Rakesh was very glad that he was able to pitch in to help his father.

In the case of Sanjay Chaudhary the circumstances were different. He had to undergo a heart surgery as a critical life saving measure.  Unfortunately for him, he did not have insurance but his daughter, Srijitha, a chartered accountant employed with Ford came to his rescue and quickly ramped up the funds with a personal loan for Rs. 4 L.

The circumstances under which these personal loans were taken is a good indicator that the bank is not concerned with the end use of the personal loan but only with the individual’s ability to repay.

Why do people opt for a personal loan?

Here is a quick survey done by BankBazaar.com to figure out how personal loans were actually spent by their applicants.

For a family emergency

As evident with some of our loan applicants described above, family emergency seems to top the charts as one of the biggest reasons why people opt for a personal loan. Nearly 37% of personal loans fall in this category.

For repaying borrowed money

One of the typical uses of a personal loan tends to be for repaying small loans borrowed from friends and relatives. Sometimes people also take a sensible decision to repay pending credit card payments through a personal loan, as the interest on a credit card can be much higher than the interest rate on a personal loan. This constitutes around 10% of the loan applicants.

For buying household appliances

Personal loans are also used to buy appliances such as TV, refrigerators, air conditioners etc. This is mainly opted for by people who feel such a purchase will cause a dent in their monthly budgets. Around 16% of the loan applicants opt for this.

For holiday travel

This is one of the emerging areas where personal loans are utilised. This is generally taken by people who have the means but are facing a temporary lock in of funds. This works for around 5% of the loan applicants.

For marriages and functions

People often opt for a personal loan when there are big occasions like marriages or other family functions. Today, marriage parties cost a significant amount of money. About 17% of the loan applicants spend their loans this way.

For the down payment of a home loan

Many individuals opt to take a loan of a couple of lakhs to top up their down payment for a home loan, when they are a few lakhs short of the required amount.  Around 15% of the loan applicants take up this option.

Who takes a personal loan?

From a bank’s perspective, there are two types of borrowers. The former has a high credit risk and hence is given a secured personal loan against some form of security like property, shares, gold etc.  Such loans cease to be strictly personal loans. The latter has a low credit risk and become eligible for an unsecured loans.

It is immediately evident that the salaried class are a perfect match for this low risk category where the default levels are likely to be lower for the banks. In fact, if you are not in full time employment, it will be difficult to get a personal loan.

People who take personal loans are usually in their 20s or 30s. Almost 80% of the loan applicants are in the age group of 25-35 years.  These individuals live in a credit culture where a personal loan, despite high interest rates, is an acceptable form of fulfilling needs and desires.

The size of the loan depends on the place, in other words, based on the average living expenses of a particular city or town. In tier 2 and tier 3 cities, majority of the people opt for a personal loan worth anywhere between Rs.50, 000 to 1 L. In tier-1 cities and metros, the majority of personal loan borrowers opt for sums anywhere between 1 L and 3 L.

Repayment

There was a time in mid 2000s, when banks were more lenient with sanctioning a loan. The conditions were more flexible for disbursing a personal loan. Similar to credit cards in early 2000s, there were several defaults as well on a personal loan.

However, all that has changed drastically. Banks have become strict in lending a personal loan in the past 3-5years. Default levels were in the range of 14% to 17% as recently as 2008. Since the economic meltdown, banks have tightened eligibility norms and the default rate has come down to less than around 10-12% now.

Banks have now become very selective in disbursing a personal loan with employed individuals given the highest priority, as indicated earlier. Added to that if you are an existing customer of the bank you definitely stand to gain a better interest rate as well!