Purpose of personal loans

What's the quickest way to raise a few lakhs? You could, of course, pawn your wife's jewellery. Or, go around cap in hand, to friends and relatives. But there is another way out if you need money urgently and aren't expecting to win a lottery in the immediate future.

It's an expensive option but you could take a look at the personal loans offered by banks such as ICICI Bank, ABN Amro, Citibank, HDFC and Standard Chartered.

These loans, as opposed to others, can be used for anything -- for your holiday abroad to repairing your house. No questions are asked and the money is yours to do as you like -- though the banks safeguard themselves legally by inserting a fine print clause saying that the "money should be used for a legal purpose".

Getting the cash is easier than you might expect. A salary slip, proof of personal identity, residence proof and signature will do just fine. Other things that most banks demand are passport-sized photographs and credit card statements.

The most significant thing about personal loans is the fact that you do not need to provide any collateral -- these loans are issued without any security. However, this has a downside as the interest rates are much higher, ranging from 16 per cent to 22 per cent. All other rates including service charges and pre-payment penalty are higher as well.

Most banks will give you anywhere between Rs 20,000 and Rs 10 lakh (Rs 1 million) for a maximum period of 60 months. To be eligible for the loan you need to be between the ages of 25 years and 58 years in case of a salaried individual or between 25 years and 65 years if you are self-employed.

While issuing the loan, banks look at factors like your salary or profit, the number of years you have worked in a particular organisation and the number of years you have stayed in your current residence.

For instance, at ICICI Bank, your net salary needs to be Rs 96,000 annually or you need to have a net profit after tax of Rs 60,000 per annum. If you are a salaried individual you should have worked in your current organisation for at least one year and if you are self-employed then you must have been running your business for at least three years. You must have also been in your current residence for at least a year.

The loan is sanctioned within three working days. The processing fee is generally around 2 per cent of the loan amount and is deducted upfront from the disbursement amount. Most banks charge pre-payment penalty of between 3 per cent to 5 per cent of the remaining amount.

However, there is a catch. Most banks do not let you repay the loan before 180 days. So even if you end up getting some extra money, you are stuck with the loan and the interest rate.

Though the interest rates charged on personal loans are very high, taking a personal loan is cheaper than rotating credit on your credit card. Most credit card companies charge an interest of between 2.5 per cent to 2.99 per cent per month.

That works out to interest of 30 per cent to 36 per cent per annum. So if you haven't paid your credit card bill for the last few months, you would be better off taking a personal loan and repaying your credit card bill rather than rotating it.

In case of a personal loan, you have to repay the loan as equated monthly instalments through post-dated cheques. The problem with this is that you sometimes end up paying interest on an amount which you haven't yet used.

For instance, if you take a loan of Rs 200,000 of which you use only Rs 20,000 initially, you still pay interest for Rs 200,00 though it is still lying in your bank. So if you don't need the entire lumpsum in one go, you should look at products such as ABN Amro's Credit Line or Citibank's Ready Cash Account.

ABN's Credit Line offers loans for amounts ranging between Rs 25,000 to Rs 250,000. It is an unsecured, revolving overdraft for a period of maximum 12 months. Supposing you take a loan for Rs 100,000. Now if you only withdraw Rs 20,000 from this account, you will be charged interest only for that.

Payment is made not through EMIs but instead you are sent a bill asking you to pay the interest and a part of the principal. The interest varies between 18 per cent and 22 per cent.

Similarly, in case of Citibank's Ready Cash Account, a bank account is opened in your name and cash is deposited in the account. The bank will loan up to Rs 10 lakh, for which interest must be paid only on the amount withdrawn.

To save further on interest, you can simply deposit any additional money in this account. Citibank also offers a Ready Cash card which is an ATM and debit card. Whenever you use it, money will be withdrawn from your ready cash account.

But, whichever way you cut it, personal loans are an expensive option only to be used when you really need it.