Every individual or small business, at some point can find themselves in a cash crunch situation. If you are an individual, your needs can range from home renovation to, paying for child’s education expense or it can be an emergency/unexpected expense. As a small business, your needs can range from paying off a certain bill for which you don’t have the money at hand, or it can be larger expenses like providing an employee with a motorbike. These expenses can be managed easily either through a personal loan or a running finance facility through a financial institution in the Pakistani market.
Banks in Pakistan offer different kinds of consumer loans that an individual or small business can avail to cover their expenses while cash is short. As a consumer, we must know which product will suit our needs. This article will explore different features of two types of borrowing facilities so you can make an informed decision.
Personal Installment Loan:
An installment loan is a type of loan in which a specific amount is lent for a specific time and is repaid, with interest, over a period of time through either monthly, quarterly or other payment designed by the bank. The duration of the loan can be in the range from 1 to several years. All mortgages and auto financing are types of installment loans. So, if you were to purchase a bike or a car or go for home repairs, the most obvious choice should be opting for a personal loan.
These loans can be either secured or un-secured. For example, in case of auto finance the car will be the collateral. If the borrower misses a few installments or is unable to pay the installments regularly, the bank can use the collateral to recover the loan. This means that if you were to miss installment payments, the bank would take back the car from you.
Unsecured loans have higher interests rate in comparison with the secured loans because of the risk involved at the bank’s end. Unsecured loans are also harder to obtain because of this risk. This means that the bank is giving you a loan without having any collateral against the loan, which means recovery in case of missed payments could be problematic. Personal loans fall under this category because they are given as an unsecured loan while specific needs are catered to by specific loans and leases like Car Loans and House Financing.
Another important feature of these loans is that they can have a fixed rate or the rate can change over the period of time.
In Running Finance, also known as revolving credit (AKA Ready Line, ReadyCash etc.), instead of getting the entire sum of money you are given access to a draw down limit. And instead of charging interest on the entire amount (like on installment loans) you are only charged on the amount that you withdraw.
For example, you and your bank offers you a running finance facility with a maximum limit of 500,000. And somewhere down the line you need to withdraw 100,000. In this case, you will be charged only for the 100,000 you withdrew meaning you will pay interest on the 100,000 and not on the entire sum of 500’000. You can still avail the remaining 400,000 as an when required. So, this is a revolving limit, the minute you pay back the 100,000, you have the full 500,000 to avail whenever you need. A classic example of this is your credit card. You can pay your emergency medical bills when you need, and interest would be paid on any drawing on your card, not on the full limit.
Installment Loan vs. Running Finance:
Now with all the information that we have so far, how does one decide which option to choose. The answer depends upon your need, your credit history and somewhat on how good or bad you are with money.
If you have a predetermined amount of money in your mind for a specific purpose, installment loan is a better option.
For example, if you want to pay for renovations around the house, an installment loan will serve the purpose. For any unexpected or unforeseen expenses, like admission fee for your child, or for educational expenses for college; it’s better to use a running finance facility.
You can check out how much installment you may have to pay by using the financial calculator (insert hyperlink for our calculator).
Running finance is beneficial when you don’t have a definite idea how much money you will need or when the money will be required. Having access to a running finance facility is always a good idea, since it can be great help when you run in to an emergency.
Most banks offer personal loan and running finance options such as Silk Bank or Standard Chartered Bank. Some Islamic Banks such as Meezan Bank may not provide you with unsecured personal loans due to Shariah restrictions. Similarly, most banks offer running finance facilities for small businesses and for individuals as well.
For personal loans, banks open a line of credit for you and you can access funds offered through cheque or debit cards. The interest rate is calculated using the KIBOR benchmark which is the interbank rate for borrowing and lending.
For running finance, you are assigned a limit where you can borrow up to your requirement and then pay back on a month to month basis. Again, KIBOR is used as a benchmark to mark interest on your borrowing. And borrowing can be done through cheque as well.
Whether you are applying for an Installment loan or Running finance, the one thing that will determine its success will be your financial discipline. If you don’t have a plan to return the loan or you spend money for the sake of spending money, then it may not be such a good idea to borrow.
But with a better management it will help your credit score to boost and bring financial benefits for further loans. Good credit history gives you better opportunity to avail bigger loans for important expenses like longer term loans for asset purchase like cars, houses, machinery, etc.