The elusive choice in absence of collaterals

Expansion of access to unsecured credit has been largely led by two key catalysts over the last few years – India’s maturing credit bureaus along with data-and-technology-led digitalisation. Both have helped lenders access structured consumer data at scale for underwriting and strengthen distribution capabilities, paving the way for high growth of personal loans.

Till a decade ago, personal loans were restricted to a few segments, with large sections of the population relying on collateral-based secured loans like gold loans or loans against property in times of need for funds. Today, loans against mutual funds, used cars etc., are also options as collateral-based loans. But for many without collaterals, personal loans remain the only elusive choice.

While access to personal loans has grown exponentially, some nuances remain. Personal loans, being collateral free or unsecured, work on the fundamentals of creditworthiness more than any other form of loan. By factoring in multiple aspects, lenders evaluate the delinquency risk and lend accordingly.

Pledging collateral benefits both parties. For lenders, it serves as a safeguard in the event of default, while for borrowers, it enables access to relatively relaxed loan terms such as lower interest rates and higher loan amounts. On the contrary, for unsecured loans, the borrower is the security. The borrower’s financial and credit health is vetted thoroughly to understand the risk involved, drawing on multiple data-points across the financial ecosystem.

Products like unsecured personal loans, cash-flow-based business loans, overdraft facilities, consumer durable loans, etc., are prime examples of loans without collateral.

For instance, in cash-flow based lending, lenders view transaction patterns, money inflow and outflow, and business bank statements to determine financial stability and creditworthiness. Same is the case with personal loans, where the borrower’s repayment patterns, income patterns, and financial stress signals are assessed. This approach allows even asset-light borrowers to access funding.

Lenders usually evaluate two parameters — capacity to repay and intent to repay the loan. Your income determines your capacity to repay a loan whereas parameters like the credit score and credit profile are put under the lens for assessment of intent to repay the loan. Lenders analyse the likelihood of getting their money back by factoring in all these signals. Access to personal loans becomes relatively easier when the borrower showcases a stronger credit profile and stable income.

A credit profile of a borrower equips lenders with essential financial information, including repayment history, credit utilisation, debt obligations, etc. Borrowers reflecting consistent, timely repayments in their credit reports are seen as low-risk and are more likely to receive easy approval and better terms, while irregular repayment patterns trigger caution and stricter lending conditions.

A CIBIL score of 760+ is preferred by lenders especially when approving an unsecured loan. A higher credit score typically translates into lower interest rates and more favourable loan terms. Maintaining it requires consistent repayment behaviour and a well-managed credit profile.

Income stability and a steady bank balance is another factor that lenders look at closely.

With better access to financial data and more refined risk models, lenders can take informed calls without relying solely on collateral. That said, the trade-off still remains.

In the absence of collateral like gold, the risk for lenders is higher. Consequently, the lending rate is usually higher as compared to secured loans. Additionally, the loan amount offered for unsecured loans may also be lower than secured loans, where the loan amount depends on the cost of the collateral.

Ultimately, the choice between secured and unsecured credit must align with a borrower’s needs.

(The writer is CEO, Paisabazaar)