What you need to know about personal loans

People take out personal loans for various reasons, including to cover unexpected expenses, home renovations, education fees or starting a business. It is easy to understand why people take out personal loans, but it is more important to understand how these loans work.

Consumers do not always know if they will qualify and what their responsibilities are if the loan is approved, says Neven Narayanasamy at specialist loans provider, DirectAxis.

“Before applying for any form of credit, it is important to understand the product and how it works, its benefits and what your obligations are. Only then can you make an informed decision.”

A personal loan is a type of credit where you borrow a lump sum. You must then repay the borrowed amount, plus interest, in monthly instalments over an agreed-upon period, typically ranging from 24 to 72 months.

In South Africa, personal loans are normally unsecured which is 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.

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How to qualify for a personal loan

Lenders 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 that you will not repay the loan.

Narayanasamy says there are many ways to find out what your credit score is and whether you may be eligible for a personal loan, including DirectAxis Pulse, a financial-wellness tool that allows you to check your credit rating and how to improve it.

While the application process should be quick and easy, the loan provider must do some checks prescribed by the National Credit Act. The credit prover is responsible for checking to ensure that 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 that confirms your residential address.
• Proof of income. If you are employed you can provide a copy of your latest payslip and a bank statement. If you are self-employed you must submit at least the last three months’ bank statements.

To approve the application, the credit provider confirms your credit score, income and any money you owe, as well as calculating how much debt you have compared to what you earn.

Narayanasamy says it is 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 really need the loan, it is not in your best interests to exaggerate your income or conceal information. These safeguards are in place to protect you and if you cannot afford the loan you should not be taking it, no matter what the circumstances.”

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Once your personal loan is approved

Once your loan is approved, the 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 and your financial position, as well as your preference for repayment.

The longer the term, the lower the monthly payments, but remember you will also pay 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 a number of qualifying debt repayments into a single monthly payment at a fixed interest rate, a process called consolidation.”

Narayanasamy says whatever your reason for applying for a personal loan, understanding the commitment you make will enable you to make an informed financial decision.