A personal loan allows you to buy goods and services even before the customer is able to pay for them. In any country, most people find it difficult to save up the money needed to buy expensive cars or home appliances. By taking a loan and repaying it in monthly installments, people avoid to save up funds before making a purchase. The development of this loan type begins in the 1920s and coincides with the start of mass cars production. A loan with an installment payment became the basis for the car market development. Thus, the loan issue for the purchase of a car still occupies a leading place in personal loans.
For what purposes and what amount can you get a loan today? What are the return terms? Why are lending institutions expanding the provision of such services? Let’s try to find answers to these questions.
A personal loan is usually issued to buy durable goods such as cars, furniture, carpets, TV sets, as well as to pay for medical services, recreation, etc. Banks also provide personal non-targeted loans, it is not required to indicate the product you are going to buy. This form is called as a renewable credit.
Both consumers and lenders find it more convenient to repay a loan in installments, and the overwhelming majority of loans (about 90%) are provided with an installment plan. Payments are made, as a rule, on a monthly basis. Personal loans without installments can be repaid in one installment, or a payment account is opened for the client. Loans without installments repayment are provided for the same purposes as with installments, but usually their amount is less, and the repayment period is up to 12 months. These loans are more often used to pay for services such as medical bills.
Targeted loans can be provided by commercial banks in 50%. Other 50% of targeted personal loans are provided by companies selling durable goods, financial companies, credit unions and some others. Depending on where the loan is taken, the consume finds himself in a different position in relation to the purchased item. When buying on credit, the goods remain the property of the financial company until the last payment. And if you decide to use a bank loan, then the bank, having agreed to provide a loan, transfers money to the client’s current account and the purchase of goods is paid immediately in full by check. The purchased items immediately become your property, as if you paid for them in cash. Actually, the seller does not have to know that the buyer has borrowed money.
The participation of commercial banks in lending to consumers is not limited to issuing loans to them (direct lending). Banks also buy debt obligations of consumers from sellers of cars, furniture, refrigerators, washing machines, TV sets, etc. Such obligations with the attached documents are called dealer paper. It is also practiced to acquire obligations related to the provision of medical services and the payment of insurance premiums. The purchase of consumer debt by banks is called indirect lending.
Traditionally, no collateral is required to obtain personal loans, but they are provided only to customers who have a current account with the same bank. When issuing a loan, the bank analyzes the client’s account for a number of years. The decision to issue a personal loan to a particular client is often made by a bank using the credit scoring method, when answers to questions are evaluated in points.
If the bank uses such a scheme for issuing loans, the client does not need to meet with a bank employee in order to get a loan: it is enough to fill out a standard form and send it to the bank, which will process it, evaluating each answer with a certain amount of points. The bank’s decision to approve for a loan depends on the points collected. If a client meets a certain significant number of points in total, the loan is issued. But, despite the existence of such a system, the provision of a significant part of loans today depends on the opinion that a bank employee develops during a personal conversation, as well as other information available to the bank.
Most banks, when issuing personal loans, use schemes that include life insurance. In the event of the borrower’s death during the period for which the loan was received, the debt is repaid by insurance payments. There is often an upper limit on such insurance.
When providing a targeted consumer loan, banks necessarily require the client to partially pay for the purchase at his own expense. When determining the amount of this contribution, banks apply two “golden rules”:
- the first installment must be large enough for the buyer to pay a significant share of the product cost and can feel himself as its owner;
- regular payments must be sufficient so that the paid share of the value of the goods increases faster than the wear occurs.
It is believed that if the down payment and monthly payments do not meet these requirements, the buyer may feel like he is renting the item rather than owning it. Therefore, banks give preference to large installments and short loan terms. The terms for them are different. Durable goods are usually purchased for 2 years, a new car – 4 years, mobile homes – 10 years.
When buying a new car, the buyer’s fee can be a quarter of its value. Most people provide this premium by selling an old car. If you decide to buy a car for $10, 000, then the bank will give you a loan in the amount of no more than $7,500. You will have to return to the bank an amount exceeding $10, 000.
If the client, for any reason, is unable to make timely contributions, the ownership is transferred to the bank and he tries to collect the unpaid amount by selling the car.