These days, it is not uncommon to find at least one e-mail per day about instant or pre-approved personal loan in your mailbox. The creative teams at banks can actually make you feel that the offer has specifically been customized for you. Do not fall for the attractive advertisement. You must avoid personal loans to the extent possible. However, if you are borrowing for an emergency, these are a few things you must keep in mind before availing personal loans.
Flat Interest Rate or Reducing Balance Interest Rate
Do not just fall for the lowest interest rates. Do read about whether the loan is offered on flat interest rate basis or reducing balance basis. Flat interest rate loan are typically offered at much lower interest rates. However, that does not mean you are going to pay less. For more information on flat rate and reducing balance interest rates, please go through the following post.
Assess the All-In Cost
Interest cost is not the only cost that you have to bear. There are other charges too. Consider the following costs.
Processing Fee: Typically, banks charge up to 1-2% of the loan amount as processing fee. A few banks charge a flat processing fee. These charges add to the total cost of loan. Lower the processing fee, the better.
Prepayment Fee: Sometimes, you take personal loans to tide over the short term cash flow crunch. In such cases, prepayment of loan is a possibility when the cash flows improve. By prepaying the loan, you can save on absolute interest cost. If you fall in the same category, do consider prepayment penalty costs while trying to assess all-in cost. Banks use prepayment penalty as a tool to ensure that the borrowers stay in the loan and bear the full interest cost. Lower the prepayment penalty, the better.
Late Payment Fee: Credit institutions levy penalty (late payment fees) in case you are late on EMI payment. If you are struggling with cash flows, do consider this penalty too.
Consider Your Needs, Not Eligibility While Borrowing
If you need Rs 3 lacs to meet a short term need, borrow only Rs 3 lacs. Sometimes, bank executives may try to convince you to borrow more (say Rs 5 lacs) only because you are eligible. You must have received e-mails and cold calls from the banks/credit institutions for the same. A personal loan is one of the most expensive forms of debt. Why do you want to pay interest for the money you don’t need? Don’t fall for the ego massaging sales pitch. Borrow only as much as you need and not more.
Shop for Better Rates
Shop around for better rates. Do not actually apply to check the rates. This will result in hard enquiries on your CIBIL score and may adversely impact your credit score. You can check the prevailing rates by calling customer care.
Make Sure You Can Service the EMIs
Be honest to yourself. No one knows about your repayment ability better than you. Not even your bank does. Do an honest assessment. If you feel you cannot service the personal loan EMIs, do not take a loan. Try talking to friends and family. Failure to service EMIs will result in penalties and also spoil your credit history.
Check Your CIBIL Score before Applying
Banks and other credit institutions consider your CIBIL score while sanctioning loans. A low credit score can either get your loan application rejected or the bank may increase the interest rate. Hence, if you are planning to apply for any kind of loan, it makes sense to check your CIBIL score before applying. These days, CIBIL scores are made available instantly for a small fee.
Avoid Add-On Offers
Sometimes, while selling personal loans, banks also pitch for additional products such as accidental insurance plan. You are told that you will not have to pay anything upfront. The insurance premium will get added to your EMI. Simply say NO. As if paying high interest on loan was not enough, you have to pay interest on insurance premium too. Your circumstances can force you to take a personal loan. However, if you start falling for such add-on offers, there is no excuse. You are the only one to blame. Accidental insurance is just one example. There can be many such add-on offers. Learn to say NO to such offers.
Talk to Friends and Family
If you are taking personal loan to tide over short term cash crunch, try talking to friends/family if they can lend some money. Perhaps, they won’t even charge any interest. However, be sure you can return the amount as promised. Otherwise, you might end up jeopardizing the relationship/friendship. Therefore, be honest to yourself and your friends/family about your repayment ability.
Avoid Personal Loans
Last but not the least, avoid personal loans unless necessary. Sometimes, due to short term cash crunch, a personal loan might be the need of the hour. However, personal loans taken for vacation and latest fancy gadget is a strict no-no. A personal loan, with the exception of credit card debt, is the most expensive debt available in the formal banking sector. The interest rate may range from 12% to 30% per annum. Hence avoid such loans to the extent possible.
Do not take a personal loan unless in case of an emergency. Read the terms and conditions of the loan before signing the dotted line. Do not just go by the rate of interest. Assess the total cost for comparison.