Pratik realized it only late in the day that the money he had in his savings account would not be sufficient for the interior works of his newly purchased apartment. The only way out for him was to take another loan to meet the financial requirement. He had almost exhausted his savings after making the down-payment and meeting the registration expenses of the new house. He decided to choose between the two most popular loans that are handy for anyone in need of immediate money—personal loan and credit card loan. His bank offered him a personal loan of 5 lakhs. The credit limit of his card was only 2 lakhs. His friends told him that personal loan was a better choice than a credit card loan that comes with high interest rate and charges. Pratik decided to make his own judgment between the two and compared the two loans with the below yardsticks.
1: Application Process
He compared the application process for both personal loans and credit card loans. Both loans are offered after due diligence, but credit card loans are easily available. While he can apply for a personal loan online, he will have to submit his pay slips, Form 16, bank statements and KYC documents for getting the loan application physically processed. Also, the process may take 48-72 hours, and it can even go up to a week in some cases. For a credit card loan, all he has to do is to dial up the customer care number of his card and request for a loan. The amount requested will be credited to his account within 24-48 hours.
2: Processing fee and Pre-Closure Charges
Both personal loans and credit card loans come with 0.5-1% processing fee. This means, if he is taking a loan of 2 lakhs, he will have to pay Rs.1000-2000 as processing fee. Both loans come with pre-closure charges of 2-5% of the principal outstanding. Credit card loans come with an option of lower tenure, with tenures as low as 6 months available. On the other hand, most banks offer personal loans for minimum 12-24 months.
3: Quantum of Loan
If one needs a small loan, credit card loans come in handy. On the other hand, if one needs more money, personal loan is a better option, as the credit limits of cards are usually limited. In most cases, a personal loan is offered up to a certain multiple of the net monthly income of the applicant. Credit cards may not give you such a big cash limit, as the common parameter across banks is to offer a loan as per your maximum credit limit.
4: Interest rate
This is the most important yardstick for comparing personal loan and credit card loan options. Personal loans usually come between an interest rate of 13-22%, while credit card loans are offered at 10-18%. If someone is being offered a deal of 10% on his credit card, it apparently looks more attractive than a personal loan offered at 16%. But the caveat here is that credit card loans are offered at flat interest rates, while personal loans are offered at reducing balance rates. In flat rate loans, the monthly interest is calculated on the initial amount of loan taken and it will be so throughout the tenure, even if the principal amount reduces. But in a reducing balance loan, the interest outflow reduces as the principal gets paid off.
So, a personal loan at a higher rate in most cases will require a lesser interest outflow than a credit card loan at lower flat rate. However, if the tenure is lower, say one year or two, a credit card loan at a lower flat rate will be better than taking a personal loan for 5 years.
After comparing the two loan options, Pratik decided to go for credit card loan. The reason was that, his fund requirement was only 1.5 lakhs and for a short tenure of say 6-8 months. He was expecting his yearly incentives within 6 months and he could easily close the loan as soon he got the incentive.
So, a credit card loan at a flat rate appeared to be a much better option for him than a costly personal loan at reducing balance rate. The key here is an understanding your financial needs before weighing the pros and cons of different loan options. Both credit card loans and personal loans are easily available, but neither one fits all needs. Your specific financial need is key to making the right choice.
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