The Truth behind Pre-Approved Personal Loans

Ever received an e-mail about pre-approved loans from your savings bank or credit card issuing bank? Most of us will answer this question in the affirmative. The e-mail is typically about a pre-approved home loan or a personal loan. The frequency of such e-mails is quite high too. I get an e-mail from my credit card bank once every two weeks.  Given the high frequency of sending out such e-mails, at some point, you are bound to feel thankful for such e-mail. For instance, you are planning to renovate your house and the tentative cost is Rs 15 lacs. The very next day, you get an e-mail about a pre-approved personal loan of Rs 15 lacs. It would seem as if the God wants you to renovate your house. And the tone is congratulatory. It is as if you have won a free trip to Europe.



There is no need to flatter yourself. There is nothing monumental you have done by being an account holder with a particular bank. There is one thing you need to be sure of. With banks, nothing is ever free.  The banks are at their dangerous best when you don’t doubt their intentions. I am probably stretching the argument too far. You cannot expect banks to offer you a loan without interest.

Coming back to the topic, here are a few things that you need to keep in mind while opting for such pre-approved loans.

The Pre-Approved Loan May Not Be Completely Approved

Banks typically offer pre-approved loans to their existing customers. Your bank can do this because it has good information about your transaction history, income, balances etc. Hence, it is easier to form an opinion about your credit-worthiness. Typically, banks check your credit score once you apply for the loan since there is some cost involved in accessing the CIBIL or credit score. Hence, if your credit score is not good, your loan request (even though pre-approved) can be declined.

With home loans, the bank needs to check many documents before it makes the final decision.

Even with personal loans which are unsecured, there might be an additional approval step involved before the loan amount is disbursed to you.

Do note that applying for a pre-approved home loan is merely a show of your interest in the offering and sets off a long offline process. This is along expected lines. Personal loans are unsecured loans and can be disbursed quickly. Home loans require much greater due diligence. There is security to be created and documents to be signed.

Such Loans May Be Disbursed Quickly. i.e., Lower Processing Time

A pre-approved personal loan can be disbursed much quickly. Since personal loans are unsecured, there is no documentation to be done for creating security.  The bank already has a good idea about your credit-worthiness based on your transaction history. In some cases, the funds can be released to you in a matter of a few hours. This may be helpful for those in urgent need of funds.

In case of a pre-approved home loan, bank will do further due diligence and hence it will take some time.

Ability to Negotiate Interest Rate or Charges

I have read that your ability to negotiate various charges is higher in case of pre-approved loans.  I have read that you can ask for relaxation on processing fee and other charges. This may not be true in all cases. If you are applying for the loan online, there is no way you can negotiate at least for personal loans. Who will you negotiate with? The bank, if it approves your online application, will credit your bank account or send you a draft. There is no scope for negotiation. Such negotiation can only be done with a bank official. You need to visit a bank branch if you want to get finer rates. After seeing such an e-mail for pre-approved loan, you can visit the bank branch and try to negotiate various charges.

The Pre-Approved Loan May Be at a Higher Interest Rate

I get two types of personal loan offers through e-mails from my credit card issuing bank. One is pre-approved and is at a rate of 14% p.a. The other one is regular information e-mail detailing the bank’s personal loan offering starting at 11.49% p.a. For the second type of loan, you will have to follow the regular application process.

You can notice the difference in the interest rates. Pre-approved loan is at a much higher rate. I am not saying you will get the loan at 11.49% p.a. in the second option. However, if your repayment ability is good and you have a good credit score, there is no reason why you shouldn’t get personal loan at less than 14%. Moreover, since you will be interacting with branch officials, you may even be able to negotiate other charges too.

Processing Fee, Transaction Fee and Pre-Payment Charges

I will list down the charges and term and conditions of the personal loan offered by my credit card issuing bank. Your bank may have different terms and conditions.

Even though the loan is instant and pre-approved, there is still processing fee of 1%. Hence, if you have been made an offer of a loan of Rs 5 lacs, you will be charged a processing fee of Rs 5,000. And yes, there is service tax.

In addition, there is a one-time transaction fee of 2.5% of the loan amount.

If you want to prepay the loan, there is prepayment penalty of 3% on the outstanding principal amount. Banks are permitted to charge pre-payment penalty for fixed rate loans such as personal loans. Hence, if you had taken a loan to tide over a very short term crisis, exit is not easy for you.

In most cases, as soon as you accept the terms and conditions, the money will be credited to your account (or draft sent) in a few hours or days. In other cases, there might be an additional approval step and the amount is credited to your account post approval. The processing fee and transaction fee will be adjusted against your loan amount. Hence, if you opt for a personal loan of Rs 5 lacs, you will get Rs 4.79 lacs in the first place.

Rs 5 lacs – Rs 5,000 (processing fee) – Rs 12,500 (Transaction fee) – Service Tax

By the way, you pay interest on the entire 5 lacs. Hence, the bank has taken out Rs 20,000 even before you got any money. So, essentially, by extending this loan to you, the bank has booked an upfront income of Rs 17,500 for this loan. Service tax goes to the Government.

How does this affect the cost of loan? Though the interest rate of the loan is 14% p.a., you didn’t get the entire amount in the first place. You got only Rs 4.79 lacs. With such high charges, for a personal loan of Rs 5 lakhs for 3 years, the effective cost of loan comes out to 16.9% p.a. Too high, isn’t it? This is why you should avoid falling for this trap unless an emergency forces your hand.

Do note your bank may offer different terms. Since everything is online, make sure you check all the charges and terms and conditions before you press the Submit button.

Process of Availing Such Pre-Approved Loan

I will talk only about personal loan. The steps are based on the offer made by credit bank issuing bank.

  1. Login into Internet banking site of the Credit card issuing bank.
  2. Click the Loan Offer.
  3. Select the Credit Card Number ( in case you have multiple credit cards)
  4. Choose Amount and Tenor (the amount in my case was fixed. I could select only the tenor)
  5. Select the city at which the draft shall be payable. I do not have savings account with the bank. With other banks, the amount could be credited directly to your bank account.
  6. Specify the purpose of loan.
  7. Enter personal details such as employment status, profession and education.
  8. Click Submit.

On approval, the loan draft will be sent to the mailing address in 3 days. The application process is so simple that you may forget to check various charges. Do not make the mistake. In my case, processing fee was on expected lines. However, transaction charge of 2.5% came as a surprise. I stopped short of applying for the loan. You can see the loan is not completely approved yet. The bank may ask for additional documents.

Conclusion

Avoid these loans unless absolutely necessary. Taking such loan for a medical emergency is acceptable. However, taking such personal loan for a vacation abroad is outright criminal. I would rather wait, save and take vacation next year. As I have mentioned many times before, do not take a loan just because you can take it. Borrow only if there is no other way out. Consider the repayment ability. The EMI for such loan will put extra burden on your cash flows in the coming months. Be doubly sure that you can repay the loan comfortably.

Explore other options. For instance, if you are planning to borrow for house renovation, do consider top-up home loan before you sign up for personal loan. In case of medical emergency, talk to friends and family for a hand loan.

In case you have to opt for such loan, do not just focus on the interest rate. Focus on other charges too.