Be it new furniture, impending renovations to one’s house, or even the financing of that new car – a personal loan can be taken out for any number of different reasons. But what precisely is a personal loan, and what should potential borrowers know before taking one out?
Switzerland’s Consumer Credit Act (CCA) defines a personal loan – also known as a private loan or small loan – as an interest-bearing loan which:
- is between CHF 500 and CHF 80,000;
- has a term of more than three months;
- is not secured by deposited collateral;
- is exclusively used for private purposes.
If a loan is raised for purposes of financing professional or commercial investments, such as an investment in a person’s own company, it is by definition not a personal loan.
Broadly speaking, personal loans can be broken down into two types: off-line loans, where the borrower visits the bank branch, and online loans, which are concluded over the Internet. Nowadays, financial institutions often offer both options. In addition, private individuals have recently been able to grant loans to each other via online fund-raising marketplaces (“crowdlending”).
How many Swiss take out a personal loan?
Personal loans are more popular in Switzerland than you might think. At the end of 2016, no less than 375,909 outstanding personal loans with a total volume of just under CHF 7.1 bn were registered with the Central Office for Credit Information. In addition, a representative survey carried out by comparis.ch in 2017 revealed that one in every three Swiss has taken out a loan of this kind at some point. The survey also showed that personal loans are used most commonly to finance the purchase of a car or to bridge a period of financial difficulty, above all as a result of unforeseen costs arising. However, demand for personal loans in Switzerland has been in decline for the last few years.
When does a personal loan make sense?
The question of whether a personal loan makes sense will depend on the individual situation. The advantages and disadvantages of taking such a step need to be carefully weighed up in each case. It is important that the financing desire in question is compatible with the individual’s budget. Generally speaking, a personal loan is particularly suitable when the applicant wants to:
- acquire a long-lasting product such as a car or a new kitchen, whereby the credit term should always be shorter than the expected lifetime of the object in question;
- bridge a temporary shortage of funds;
- refinance or replace an existing loan, if the interest costs can be reduced as a result;
- finance professional training or academic study if no other source of funding can be found.
When is a personal loan not a good idea?
A personal loan is less suitable in the case of short-lived consumer goods and acquisitions. In such situations, it would take the borrower longer to pay the loan off than the expected lifetime and benefits of the acquisition in question. In this case, the borrower typically finds that they are still paying off their loan many years after enjoying what it funded. Accordingly, it is inadvisable to finance holidays and weddings on credit, as here the pleasure and enjoyment gained is of only short duration compared to the repayment period.
What role does the individual’s credit rating play?
Every loan application is carefully scrutinized by the lender. The focus of this review or credit check is to assess the credit rating (i.e. the creditworthiness) of the potential borrower. This involves evaluating the probability of the applicant being able to pay back the loan according to the loan repayment schedule. A loan will only be granted if the individual’s credit rating is sufficiently high.
A credit check involves taking into account the entire financial situation of the applicant, as well as risk factors such as age, nationality, residential status, and frequency in changes of job or domicile. It is important to remember that loans are only granted to adults who are gainfully employed and have a regular income. In Switzerland, it is commonplace for Swiss residency to be a prerequisite for obtaining a loan. Furthermore, the credit check will also involve obtaining information from debt collection offices and external databases of credit ratings. If the applicant is the subject of ongoing debt proceedings or has had a credit application refused in the past, they will find it extremely difficult to obtain a personal loan.
Irrespective of the basic decision on acceptance or rejection of the credit application, the applicant’s credit rating is also key in determining the amount of interest that will be charged: The higher the credit rating, the lower the rate of interest payable. However, the loan interest will also depend on a number of other factors such as the amount, term and purpose of the loan. Interest rates for personal loans in Switzerland currently vary between 4.5 per cent and the legally stipulated maximum interest rate of 10 per cent.
Bear in mind that the applicant’s credit rating is important not just for the level of interest payable, but also for the size of the loan the lender is willing to grant. It may well be the case that the bank will not approve the entire loan amount if there are certain risk factors involved. This is also possible even if the applicant’s budget would theoretically make a higher credit sum affordable.
How can you avoid falling into credit traps?
Loan applicants can avoid falling into the most frequent credit traps by following the rules of thumb set out below:
Be wary of “teaser” offers: Lenders often try to attract potential business by advertising low interest rates of below 5 per cent. However, few applicants will ever actually be granted loans on such terms, as the majority of borrowers do not have sufficiently high credit ratings. For example, only borrowers who own their own home will ever be granted an interest rate of 4.5 per cent. In the world of Swiss personal loans, interest rates typically lie in the region of 7.9 to 9.9 per cent. Borrowers would be well advised to have an independent third party carry out a credit comparison or to obtain external advice.
Make sure you have an accurate idea of your own credit rating: All personal loan applications in Switzerland that have been turned down are registered with the Central Office for Credit Information (“ZEK”) and then stored for a period of two years. This information is available to all commercial lenders, which is why any negative credit decision will make it much more difficult for a borrower to obtain a loan elsewhere. This is another reason why it is so important to have an accurate idea of your own credit rating in advance of any application.
Choose longer terms: According to the CCA, borrowers may repay their loan early at any time. If they do so, they will then no longer be liable for the interest payments over the remaining term. As payment arrears are also reported to the ZEK, it makes sense for the borrower to choose a fairly generous credit term so that they can pay off the debt early if things work out as planned. Because to put it simply, the longer the term of the loan, the more it will cost. Borrowers are therefore strongly advised to pay off a personal loan as quickly as possible, and not to prolong the credit term unnecessarily.
Avoid dubious lenders: Borrowers should steer clear of lenders who demand up-front payments, advertise immediate cash loans, or are prepared to grant a loan without undertaking a credit check first. This kind of behaviour is prohibited under the CCA.
Avoid debt “restructuring”: A loan should not be taken out with a view to paying off existing debts, or if a household budget is frequently in the red. Such a step will only end up exacerbating the borrower’s financial problems in the medium or long term.
A personal loan can be an attractive way of bridging a short-term shortage of funds or making a long-held wish come true. But if they are to make the right credit decision, borrowers should realistically assess their financial situation before applying for a loan, and make a careful comparison of the various offers.