A Beginner’s Guide to Personal Loans
Introduction
Loans can be defined as ‘an amount of money that is borrowed—often from a bank and has to be paid back, usually together with an extra amount of money that you have to pay as a charge of borrowing’ as per the Cambridge Dictionary. People take up loans for various reasons but ultimately it is because they don’t have sufficient cash in hand readily available to procure something. Hence, applying for loans is usually the only solution for them to get the money for the time being. It is very common these days for people of all types of ages to take up loans, even minors. Unless you stand to inherit tonnes of money from your family’s wealth, you’re likely to take up a loan in the future. There are myriad types of loans offered, each serving different purposes, but this article will explore the commonly-known—personal loan.
Types of Personal Loans
Image 1: Difference between Secured and Unsecured Loan
Generally, a personal loan refers to money borrowed to be used for a variety of reasons such as repaying debt, medical bills (also applicable for insured people), contingency spending and many more. The loan’s principal plus interest is to be repaid on a regular basis (usually on a monthly basis). It is usually offered by approved financial institutions such as (banks, online lenders and credit union) and other unapproved institutions. These loans are different from other types of loan (such as car loans or student loan) as the former serves many purposes and the latter is strictly for specific purposes.
The consensus is that there are two types of personal loans—secured and unsecured. A secured loan requires collateral as part of the contractual agreement. For instance, if the borrower is unable to repay the loan, also known as ‘default’, the lender may retrieve the collateral upon defaulting the contract. Collateral could be in any form as long as they hold monetary value such as physical assets or savings accounts. On the other hand, unsecured loans require no collateral, and because of that, unsecured loans have a higher interest rate compared to secured loans. As you can see, there is no best of both worlds’ situation. It is either you are at risk of losing your collateral in the event of defaulting or you pay a higher interest rate.
What To Consider Before Opting For a Personal Loan?
As mentioned above, it has become a norm in every part of the world to take up personal loans. However, please do not succumb to peer pressure and ask yourself these few questions before taking up a personal loan.
- What’s the Intention?
Taking up a loan comes with great responsibility because of the repayment terms and interest rate, which could be overwhelming to you. I am not in the position to judge one’s motive of taking up a loan, but it is rather unwise to burden yourself by taking up a loan to buy ‘wants’ just for the sake of aesthetic values such as clothing or gadgets. Personal loans are usually taken up for important financial situations such as hospitalization or education.
- How’s your relationship with Banks?
In life, if you do something good, then you will get favour in return. The same concept can be applied with banks. If you maintain your relationship with your bank and keep on using their services. Then the bank may offer you a personal loan that is more favourable to you compared to other clients, such as giving a lower interest rate.
- Credit score
Credit score or known as CTOS score is used to represent the creditworthiness of an individual. It ranges from 300-850. The higher the score, the more favourable it is for lenders to lend to you, and this means more affordable rates can be offered to you. There are also loans offered to people with bad credit scores. These bad credit lenders may be willing to lend you money but with a higher interest rate.
- Interest rate
In hindsight, people will opt for the low-interest rate loan as it is perceived as a good deal, but that is not always the case. It can mean a longer period of repayment. So it is crucial to scrutinize which loan you are going to take. Banks usually will advertise its interest rate in nominal value, but you should always ask for the effective interest rate as compounding can incur within those periods. Hence, a compounding interest rate gives you a more accurate rate. For example, a nominal interest rate of 10% per annum if compounded quarterly will give you an effective interest rate of 10.38% per annum.
The formula for calculating Annual Percentage Rate are as below;
(where r is nominal rate and n is number of compounding period in a year)
For semi annual compounding frequency, it should be:
So here I reiterate that you should take a good look at the effective interest rate before deciding.
Alternatives for Borrowing
With that being said, there are few alternatives to a personal loan that should be considered. Remember, always keep your options open, especially when the decision is related to finance.
Credit Cards
The most common one would be credit cards. It’s very common these days for people to swipe up their credit card because it’s easily accessible but such use is capped by individual credit limits. Each bank who issues credit cards offers different types of benefits so do some research on each before applying for the card. Its downside is the hefty interest rate, and it causes a lot of bankruptcy among Malaysians including youths. So do bear this in mind before using one. One also might opt for overdraft facilities, also known as a cash line facility.
Overdraft Facilities
Overdraft facility is a type of demand loan which is offered by banks to enable a person to withdraw more money than they have in their account, and the bank determines the cap. How much you will receive from the bank is dependent on the bank’s own calculation. Though, it is very normal for businesses to opt for overdraft banks to float their cash flows. Same as a credit card, overdraft facility has a high interest rate, and there’s a commitment fee of 1% at the end of each month.
Licensed Money Lenders
Licensed Money Lenders are a type of business where they lend money to clients who pay interest. They are different from standard conventional banks because they only charge an interest rate of 12% per annum for secured loans and 18% annually for unsecured loans. It has become not unorthodox for people to borrow from them nowadays. Some might have negative connotations about them, but they might not know that these lenders are governed by the Ministry of Housing & Local Government under the Money Lenders Act 1951, which differentiates them from loan sharks. Most borrowers resort to this option because they offer attractive financing terms and faster fund disbursement. They are much lenient in accepting loan applicants compared to banks, and borrowers can choose from a myriad of loan packages. With that being said, the money lent comes with high interest.
Image 2 : List of repayment schemes offered by a licensed money lender
PTPTN
Honourable mention would be Perbadanan Tabung Pendidikan Tinggi Nasional (PTPTN). PTPTN is a government institution that offers loans for Malaysian students who are pursuing tertiary education. Specific requirements such as must have received offers to study at higher education institutions and the course you are pursuing are approved and accredited by MQA need to be fulfilled before they qualify to apply for PTPTN. but once it’s approved, I kid you not, thousands if not tens of thousands of youths will be jubilant. PTPTN are generous in giving out loans. The amount of loan given depends on household income, courses applicants are pursuing and type of education institution (public or private institutions). Applicants may receive as low as RM2850 and as high as RM50,000.
Students are free to use the money in any manner they choose to, but often end up being defaulted for spending more than they can repay. As at May 2019, around 356000 people or equivalent to 16% of defaulters have never paid their loan instalment once. Hence the proverb “do not bite off more than you can chew” is an apt observation of the issue. It is essential that students know there is an interest rate of 1% for the PTPTN loan (or they called it as Ujrah), the loan given needs to be repaid starting after 12 months of graduating and eligible borrowers need to maintain a GPA of 2.0. Severe repercussions such as being blacklisted by Central Credit Reference Information System (CCRIS) could be faced if one defaults.
Conclusion
There is no harm in taking out a personal loan, provided you have good insight of your financial standings and understand its repercussions. You may be in a rush to take out the loan, but it is best practice (not particularly about loan) to compare with other options to get the best deal. “Me, myself and I” are the only relevant individuals who can determine which loans are the best and most suitable choices for an individual (unless you have a personal financial consultant hidden up your sleeve). Whatever you do, do not succumb to peer pressure and have a clear conscience before choosing loans and always practice spending within your means.
Researcher: Emil Zaydan
Reviewer: Millen Lau
Editor: Arivaasaran Arjunan
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