Rakesh Sinha is employed with Patni Computer Systems Ltd. His father, a retired government employee, was planning to buy a plot of land that looked promising in his hometown. The only problem Rakesh’s father faced was that he was short of Rs 3 lakh; the land’s cost was Rs 10 lakh. 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 3 lakh in his salary of Rs 8 lakh per annum. He planned to repay the loan in a span of three years with an equated monthly instalment (EMI) of around Rs 10,200. Rakesh was very glad that he was able to pitch in to help his father.
In Sanjay Chaudhary’s case, however, the circumstances were different. He had to undergo a heart surgery as a critical life saving measure. Unfortunately, he did not have insurance but his daughter, Srijitha, a chartered accountant employed with Ford Motor Co., came to his rescue and quickly arranged the funds with a personal loan of Rs 4 lakh.
The circumstances under which these personal loans were taken is a good indicator that the bank is not concerned with the end use, but only with the individual’s ability to repay.
Why people opt for personal loan
Here is a quick survey done by BankBazaar.com to figure out how personal loans were actually spent by their applicants.
For family emergency: As evident in the examples mentioned above, family emergency seems to be the biggest reason why people opt for personal loans. 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 television sets, refrigerators and air conditioners. This is mainly opted by people who feel such a purchase will cause a dent in their monthly budget. Around 16% of loan applicants opt for this.
For holiday travel: This is one of the emerging areas where personal loans are utilized. 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 such as 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 downpayment of a home loan: Many individuals opt to take a loan of a couple of lakhs to top up their downpayment 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 the bank’s perspective, there are two types of borrowers. One, who has high credit risk and hence is given a secured personal loan against some form of security such as property, shares and gold. Such loans cease to be strictly in the personal loans category. Second, who have low credit risk and are eligible for an unsecured loan.
It is 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 II and tier III cities, a majority of people opt for a personal loan worth anywhere between Rs 50,000 and Rs 1lakh. In tier 1 cities and metros, a majority of personal loan borrowers opt for sums between Rs 1 lakh and Rs 3 lakh.
There was a time in mid 2000s, when banks were comparatively 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 on personal loans. However, all that has changed drastically. Banks have become strict in lending a personal loan in the past three-five years. Default levels were in the range of 14-17% 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 selective in disbursing personal loans; employed individuals are given the highest priority as indicated earlier. Add to that, if you are an existing customer of the bank, you definitely stand to gain on the interest rate.
Adhil Shetty is CEO, BankBazaar.com
Illustration by Shyamal Banerjee/Mint
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