How to Choose Personal Loan

An easy guide to unsecured loans

Debt has a bad rep. Borrow too much, and you may struggle with repayments. But debt doesn’t always deserve this bad rep. That’s because debt is a tool to manage your finances.

The RIGHT loan for you depends on your personal circumstances and needs. And there may be a whole lot of different solutions for you to choose from. If you want to know how to differentiate them and identify the factors that matter, this guide is for you.

Unsecured Loans 101

First, a quick 101 introduction.

Unsecured loans are funds lent by a bank (to a person) for personal purposes such as buying consumer electronics or household furniture, to the costs of a wedding, to consolidating other, more expensive consumer debt.

Another distinguishing feature is they are unsecured over a specific asset. So, they are based on banks’ assessment of your credit worthiness – which is, your ability to repay. Unsecured loans generally take two forms: term loans and revolving loans.


Comparing term loans vs revolving loans

  Term Loans Revolving Loans
What it is A term loan requires a set number of payments over an agreed period of time.

A revolving loan is an arrangement under which the bank offers to lend you money, up to a specific limit.

There are usually minimum monthly payments but there is no fixed period to repay the money borrowed.

You can repay as quickly or slowly as you prefer. But remember, all the time, interest charges are accumulating. When funds are borrowed, the credit limit is drawn down. And when funds are repaid, the credit limit is restored.

Example
  • Personal loans
  • Credit cards
  • Lines of credit

The 5 Common Types of Unsecured Loans

So, let’s run through the different types of unsecured loans – their key characteristics and the needs they cater for.

Debt isn’t always bad. You can use it to manage your finances.

1. Personal loan

Personal loan is a general-purpose loan from the bank, and there are no terms & conditions to what you can use it for. Personal loans are one of the lowest-cost options for buying things that you may not have ready cash to pay for upfront.

Hallmarks of Personal Loan

  • It is unsecured,
  • It is a general-purpose loan, &
  • It is for a fixed term of regular payments spread over months or years.

You can typically get a personal loan for up to 10 times of your monthly salary, at an annual interest rate as low as 3.88%. There is usually a processing fee of around 1%. The effective interest rate (E.I.R.) then works out at 7.56% p.a. The term of these personal loans varies from 1-5 years.

What is it suited for?

Why you would take a personal loan:

  • You might want to buy something that you can’t immediately afford
  • You might want to buy things without having to raise cash by selling your investments.
Pro-tip: As personal loan interest rates are relatively lower than using your credit card, take it if you qualify for it.


2. Line of Credit

Each bank names it differently. In DBS Bank, it is called “Cashline”. It is essentially an arrangement under which the bank offers an amount of funds that you can borrow –it is essentially standby cash.

Line of credit works on the revolving credit concept. This means that there is no fixed repayment term. The line of credit becomes available for reborrowing as funds are repaid. The maximum amount that you can borrow is known as the ‘credit limit’.

You will not be charged any interest until you actually use the line of credit.

Hallmarks of ‘Line of credit’

  • It is “standby cash” – interest is only charged when you draw down that line of credit.
  • Interest rates are typically much higher than for ‘personal loans’
  • If you are an existing bank customer (e.g. you have a current account, or credit your salary with the bank), the approval process can be very quick
  • There is no fixed repayment period, and you are not penalised for early repayment.

Interest rates are typically around 0.06% per day. That adds up to around 20.5% p.a. This is high but still lower than credit card rates.

You can typically get up to 4 times your monthly salary or up to 10 times your monthly salary if your annual income is more than S$120,000.

What is it suited for?

This is a loan product for those who:

  • Want convenience and easy access to cash for short periods of time, such as for a few months. It is even more convenient and cheaper than using a credit card.
  • Don’t know exactly when you need the funds. For line of credit, interest is charged only when you tap on the line of credit. In contrast, interest on personal loans is charged immediately, whether you use it or not.

Line of credit enables you to tap on the funds via internet banking, or NETS, or cheque, or GIRO, or by withdrawing cash from an ATM.

Pro-tip: But If you want to borrow for years (not just months), it makes more sense to take a personal loan instead, as they have lower interest rates.

 

3. Credit card instalment plan

This is a variation of the Personal Loan, as it allows you to buy big ticket items and make a series of instalment payments over a fixed period. The difference is you use a credit card.

In that sense, it’s like a retailer’s instalment plan with interest charges that are usually cheaper.

Typically, credit card instalment plans offer “0% interest” instalment payments. Some however charge processing fees when the retailer is not on the issuer’s list of “participating merchants”.

At DBS, there are two such plans:

  1. Instalment Payment Plan which offers 0% interest if you pay instalments on time, and no processing fees if you’re shopping through a “participating merchant”. Under this plan, your purchase will not be eligible for reward points.
  2. My Preferred Payment Plan which offers 0% interest if you pay instalments on time. It charges processing fees of 3%-6%, depending on how long the plan lasts. This translates to an effective interest rate (E.I.R.) of up to 18%.

Hallmarks of credit card instalment plans

  • You can choose your “terms” – from months to years.
  • You take the product home and pay the instalments as per the agreement.
  • There are usually penalties or administration fees for early repayment.

When you’re at an electrical/furniture retailer and see signs advertising “0% interest instalment plan”, it’s usually a credit card instalment plan with a bank.

This is how it works: Say you have a credit card with a S$5,000 limit. If you purchase a new laptop worth S$2,000 on the instalment plan, your credit card limit will be drawn down by S$2,000. So, you will have only another S$3,000 left to spend on credit, until you pay down the S$2,000 purchase in instalments.

In the background, the bank will pay the retailer for you, and then charge the total amount (plus any processing fee if applicable) to your credit card.

Meanwhile, you cannot freely cancel your credit card before completing your instalment plan. If you cancel your card before completing all repayments,

  • You will face penalties/administration fees
  • The remaining instalments will also be accelerated and everything becomes immediately payable. If you are late in your payments, you will be charged interest.

What is it suited for?

They could be a cheaper alternative to:

  • Paying with credit cards, which charge high interest rates for outstanding balances.
  • Some retailers’ own instalment plans which charge interest rates that are comparable to or even higher than credit card rates.

In other words, credit card instalment plans are an attractive method for purchasing big ticket items without upfront using your own cash, especially if no processing fees are charged.

Pro-tip: Even if you have enough cash on hand for the purchase, these 0% instalment plans may still be attractive, because it frees up your cash to earn interest in a term deposit. Provided you pay instalments on time.

 

4. Balance transfer

This service enables borrowers to consolidate debts from other accounts or credit cards onto a single credit card or credit line at lower interest charges. Banks will often offer interest free periods.

Although there are processing or administration fees, which will add on to your effective interest rate (E.I.R.), it is still a lower cost alternative to standard credit card interest rates.

There are two variations of balance transfer:

  1. Credit card-based revolving loans do not come with a fixed repayment schedule. You pay as much as you can afford, subject to minimum monthly payment conditions – as with all credit card debts.
  2. Credit line-based revolving loans perform the same, providing you the flexibility to pay at the pace you are comfortable with, subject to minimum monthly payment conditions.

Hallmarks of balance transfers

  • It involves transferring the outstanding balances on credit card(s) into a single credit card or credit line.
  • It is usually at a low interest rate or 0% interest rate with a processing or administrative fee.
  • You typically have flexibility on the repayments. But if you don’t fully repay the balance by the end of the interest-free period, you will have to pay credit card or credit line interest rates on the balance.

Typically, banks offer 0% interest rate for 6 or 12 months on their balance transfer promotions. If you have an existing credit card or credit line with a bank, you can apply fairly quickly via your digital mobile application for a balance transfer.

What is it suited for?

This is ideal if you need help managing your credit card or credit line debt:

  • Perhaps you are finding it difficult to make minimum monthly repayments,
  • As a result, interest charges are piling up, worsening the debt repayment burden.

A balance transfer provides you with better cash flow management allowing more flexibility to pay down the credit card or credit line debts.

Pro-tip: Administration fees and effective interest rates are very much lower than what is charged by credit cards. The money saved on interest payments can help in paying down revolving credit debt.

 

5. Debt Consolidation Plan

It is a debt refinancing programme that allows borrowers to consolidate all their unsecured loan balances from different financial institutions, into one financial institution.

It is a lower cost option to clear a range of debts which could be revolving at higher interest rate. The tenure of this product is generally longer and this will allow customers to paydown their debts at a more affordable instalments amount.

What are its hallmarks?

  • Interest rates are typically comparable to personal loan rates – which are lower amongst unsecured loans.
  • It is a term loan. There are fixed monthly payments over a term of up to 8 years.
  • Once the debt consolidation plan has been approved, all the accounts in other banks will be either closed or suspended.
  • Customers are granted a revolving credit facility with limit of 1X your monthly income to provide them with a convenient mode of payment for managing their daily essentials.

The outstanding balances are effectively transferred to the debt consolidation plan account. Customers are offered interest rates as low as 3.98% p.a. (7.23% E.I.R.).

So, you can effectively transfer all your outstanding balances of unsecured credit facilities across financial institutions onto a single account at a potentially lower interest rate to better manage your debt repayment.

What is it suited for?

This would suit if:

  • Your loan balances are more than 12 times of your monthly income.
  • You are finding it difficult to pay off your loan balances with multiple financial institutions.
  • You are looking to consolidate into a single loan at a potentially lower interest rate.
Pro-tip: This is potentially a way for Singaporeans and permanent residents who have borrowed too much to get “breathing room” of up to 8 years, to consolidate and clear their debts. And it comes with some of the lowest rates in unsecured lending.

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