Can I take a personal loan? Find out with these 7 questions

Take a moment to find out what personal loans are, and learn what to do if and when you need them.

A personal loan is an unsecured loan that you can use for pretty much whatever you want. You can use it to finance a medical emergency, help pay for any extra costs on a family holiday or add that much-needed flair to your wedding.

Personal loans can also be a great way to boost your cash flow to get past a short-term financial emergency. For example, if you find yourself with credit card debt, and are getting charged at least 24 per cent interest per year, consider paying it all off with a personal loan, which has a lower interest rate.

Never take a personal loan for home renovation though. Banks offer specialised loans, like a loan for home renovation or an education loan, that often have lower interest rates or requirements than personal loans.

1. How much can I borrow with a personal loan?

Generally speaking, you can borrow anywhere from two to six times your monthly income up to a maximum of $200,000. The exact amount you can borrow often depends on your salary, your credit record, and other existing credit facilities. For example, DBS offers a personal loan of 10 times your monthly salary if your annual income is $120,000 and above.

2. Do I qualify for a personal loan?

Broadly, there are 4 main things to consider:

1. Citizenship status: Singaporeans and PRs generally have lower income requirements than foreigners.
2. Employment type: Banks are more likely to approve personal loans to salaried workers. Not all banks give personal loans to commission-based or self-employed workers. Some financial institutions even have personal loans for unemployed persons.
3. Annual income: Generally, $20,000 is the minimum for a personal loan.
4. Relationship with bank: Some banks will only consider you eligible for a personal loan if you have an account or credit card with them. For example, only UOB credit cardmembers or CashPlus customers can take a personal loan from UOB.

Singaporeans, Permanent Residents and foreigners may all apply for a personal loan, though the requirements differ for each category. If you are your annual income is less than $20,000, you're not eligible for a personal loan.

Even with a $20,000 annual income, among the major banks in Singapore, only DBS and Standard Chartered will consider you eligible for a personal loan. UOB, Citibank and HSBC require an annual income of $30,000. If you're not a salaried worker (i.e. commission-based or self-employed) your minimum income requirements may also be higher. Learn more about the different eligibility criteria and current interest rates for the five best personal loans in Singapore.

If your annual income is between $20,000 and $30,000, do note that any loan you apply for will be at a higher interest rate than Singaporeans and PRs who earn $30,000 and above.

Personal loan income requirements are higher for foreigners. Generally, they must be earning at least $40,000 to $60,000 per year to be eligible for a personal loan.

ALSO READ: Why you should never take a personal loan for home renovations

3. What's the diff between a term loan and a revolving loan?

There are actually two kinds of personal loans — term loans and revolving loans.

Term loans are loans that come with a fixed period of time, as well as fixed monthly instalment payments. Because of this, the interest rates for term loans are lower, but banks may also charge a "processing fee" after approving the loan.

A revolving loan is sometimes called a personal line of credit. Like a credit card, you can use it anytime, anywhere up to your credit limit. Each month, you only need to make the minimum payment of 2.5 per cent or $50, whichever is higher. However, because of the high level of flexibility, the interest rate for revolving loans can be three to five times as high as the interest rate for term loans.

For example:

Say you want to borrow $5,000. You have the option of a one-year term loan with five per cent interest per year, or a revolving loan with 20 per cent interest per year.

If you apply for the term loan at five per cent interest a year or $250, you will need to pay 12 fixed monthly payments of $437.50 each (not including any processing fees). Should you want to make full payment before the end of the 12 months, the bank will penalise you with an "early termination fee".

Now, let's say you apply for the revolving loan at 20 per cent interest a year, you only need to pay at least 2.5 per cent of your loan amount or about $125 a month. However, for revolving loans, interest is charged daily.

Basically, that means the faster you pay back the loan, the less interest you end up paying.

At 20 per cent interest a year, your interest comes up to about $2.74 a day. If you make full payment after two months, your total interest is less than $170.

However, if you take six months to make full payment, your total interest is almost $500. And if you take a whole year before you make full payment, your total interest will be almost $1,000!

4. How long can a personal loan last?

With their sky high interest rates, revolving loans should only be used as an absolute last resort. For example, in an emergency where you can't use a credit card and you know you can make the repayment as soon as possible. You should definitely not be looking at long-term repayment for a revolving loan.

Term loans can range from one to seven years. The longer the term, the lower your monthly payments-but the more interest you incur. If you're looking at lower monthly repayments and hence a higher loan period, HSBC is a good bet. Their personal loans stretch up to seven years.

5. How do I make sense of the interest rate?

Banks know you're not stupid, but they'll still try to confuse you with phrases like Effective Interest Rate (EIR) and Applied Interest Rate (AIR). Which one should you look at when deciding which kind of loan to choose?

The lower Applied Interest Rate is usually just for advertisement purposes. It's purposely low so as to attract you. So ignore it like you would a job ad that has a vague job description coupled with the phrase "fast-paced work environment". You really don't want to know what it's hiding.

The Effective Interest Rate is the more important one of the two, and a good bank will be upfront about what it includes. The DBS Personal Loan, for example, includes a one per cent processing fee in the EIR.

But a lower EIR should not be the sole determining factor. Most banks offer lower interest rates for longer tenures, but don't be fooled-the amount of interest you end up paying is still higher.

For example:

If you want to borrow $10,000 for two years, the bank offers you an interest rate of six per cent per year or $600. That's a total of $1200 in interest you'll be charged.

If you borrow the same amount of $10,000 for five years, the bank may offer you a lower interest rate of four per cent a year or $400. But your total interest comes up to $2,000!

6. How do I apply for a personal loan?

If this is your first time applying for a personal loan, you will need to have at least the following documents:

1. Photocopy of your NRIC (both sides) if you're a Singaporean or PR. For foreigners, you need a valid passport and employment pass with at least six months' validity.
2. Proof of income
   • If you are earning a salary, you’ll need one to two of the following documents: your CPF Contribution History Statement (Latest six to nine months, depending on the bank), latest One Year Income Tax Notice of Assessment (NOA), or latest computerised payslip or salary crediting into your bank account.
   • If you are self-employed or commission-based, you’ll need your latest NOA plus optionally an additional payslip, commission statement from your employer, or CPF contribution history statement.

The exact income documents needed depend on the bank, the loan amount, and your employment status (salaried, commission-based, self-employed). For example, for salaried workers, Standard Chartered requires either your latest computerised payslip or latest six months' CPF Contribution History Statement for their CashOne loan. The NOA is only required if you're applying for higher loan amounts.

These days, many banks such as DBS and Standard Chartered let you use Singpass to apply for a personal loan. If that's an option for you, you can also submit your income documents via MyInfo with Singpass.

Do remember that banks will need to do the necessary checks so an application can take some time. Even banks that advertise "instant approval" are limited by the time it takes to validate and authenticate the information you provide.

ALSO READ: Bank loans vs licensed moneylender: Which is better?

7. What is the lowest personal loan interest rate available?

How low can they go? Well, currently, personal loan EIRs currently range from five per cent to eight per cent per annum. That being said, banks revise their personal loan rates pretty regularly, so always check our personal loans comparison page for the latest rates.

Don't forget that there are always many personal loan promotions going around. Some of these can gift you $450 in cash or even a brand new Apple iPhone! Check out MoneySmart's personal loans comparison page for the latest promotions.

ALSO READ: 6 best personal loans in Singapore with lowest interest rates (November 2023)

This article was first published in MoneySmart.