Understanding Personal Loans

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There are many reasons people take out personal loans, including dealing with unexpected expenses, home renovation, education, or starting a business – but the why’s are less important than understanding how these loans work.

Personal loans are a common way to obtain credit, but despite this, consumers aren’t always fully informed about these loans, whether they would qualify, and what their responsibilities are if the loan is approved. Before applying for any form of credit, it’s important to understand the product and how it works its benefits, and your obligations. Only then can you make an informed decision?

A personal loan is a type of credit where a lump sum is provided to borrowers.

The borrowed amount, plus interest, must be repaid in monthly installments over an agreed-upon period, typically ranging from 24 to 72 months. In South Africa, personal loans are normally unsecured. This makes them different from vehicle or home loans, where there is something of value such as a house or a car that provides the lender with some security.

Borrowers use your credit score to determine whether you qualify for the loan and to check your risk profile. The better your credit score, the lower the risk for the credit provider. There are plenty of ways to find out your credit score and whether you may be eligible for a personal loan.

While the application process should be quick and easy, the loan provider does need to do some checks. These are required by law in terms of the National Credit Act and put the responsibility on the credit provider to ensure you can afford the loan, based on the information you provide. This includes:

  • Proof of identity in the form of a clear copy of your South African identity document.
  • Proof of residence, such as a recent rates bill or similar document confirms your residential address.
  • Proof of income. If you’re employed you can provide a copy of your latest payslip and a bank statement. If you’re self-employed you’ll need to submit at least the last three months’ bank statements.
Credit score

To approve the application, the credit provider then confirms your credit score, income, and any money you owe as well as calculating how much debt you have compared to what you earn. It’s important to understand that while the National Credit Act puts the onus on the credit provider to determine whether you can afford the loan, it is your responsibility to provide accurate information and answer any questions honestly.

Although you may need the loan, it’s not in your best interests to exaggerate your income or conceal information. These safeguards are in place to protect you and if you can’t afford the loan you shouldn’t be taking it, no matter what the circumstances.

Funds are transferred directly into your account.

The time you have to repay the loan and interest, also known as the term of the loan, depends on the credit provider, the amount you borrow, your financial position as well as your preference for repayment.

The longer the term, the lower the monthly payments, but remember you will also be paying interest on the amount you borrowed over a longer period. Should you be able to do so, you can make additional payments to reduce the term of the loan and the interest.

Used responsibly, personal loans can be a useful way to deal with life’s emergencies, further your education, or finance a home improvement project that adds value to your property. They can even be used to free up some cash by combining several qualifying debt repayments into a single monthly payment at a fixed interest rate, a process called consolidation.

Whatever your reason for applying for a personal loan, understanding the commitment you are making will enable you to make an informed financial decision.