Top 5 Tips for your Personal Loans

Top 5 Tips for your Personal Loans

“Slight was the thing I bought, Small was the debt I thought;

Poor was the loan at best, God! but the interest!”

-Paul Laurence Dunbar

<b>When Personal Loans make sense…</b>

*      The interest rates offered by banks for personal loans are amongst the highest as compared to other loan types. This is because personal loans are unsecured i.e. banks do not take any collateral or security against the loan nor do they have any restrictions on the usage of the funds. It, therefore, makes sense to go for a personal loan only after ensuring that other alternatives at lower costs are not available.
*      Personal loans make most sense when there is an immediate and essential need for funds for not too long a period (the longer the duration of the loan, the higher the interest costs). The minimal paperwork makes the process to obtain these loans fairly quick.
*      It may even make sense to take a personal loan to pay off a high credit card outstanding amount. The interest rates charged by credit cards are a lot higher than the interest rate on personal loans.

<b>…and when they don’t</b>

*      It does not make sense to take a personal loan for requirements such as buying a house, home improvement or purchase of a car. These requirements can be met through alternate loan types such as Home Loans, Home Improvement Loans and Car Loans that are available at interest rates lower than personal loans.
*      If you own a property, you may also want to consider loan against property. The end use of the loan is not restricted and it works similar to a personal loan, except that it is secured against the property and therefore one can borrow larger amounts and at better rates than for personal loans.
*      Do not take a loan if you cannot afford to pay the EMIs associated with the repayment of loan. When deciding on your affordability to repay the loan, do not rely on returns you might be expecting from any speculative investments. Taking a personal loan for investments or speculative purposes with intent to repay the loan from the gains made from such investments should be a big no.
*      In most cases, it does not also make sense to take a personal loan if you have savings/investments that can be liquidated to meet your cash requirements. In case of debt related instruments (such as fixed deposits, debt mutual funds or bonds), the interest you earn will be less than the interest you pay on personal loans. On the other hand, equity and market linked investments are not guaranteed and may or may not make you money while your outgo on loans is fixed. Click here for a detailed review of the debate on savings vs. repaying debts.

<b>Interest rates should not be the only parameter to evaluate options</b>

*      When choosing from available options, do not compare only interest rates. There are other charges that banks levy which should be taken into account when selecting your personal loan provider.
*      Processing Fees: Charged by most banks either as a % of loan amount or as a flat fees
*      Pre-payment charges: If the loan amount is repaid prior to the tenure of the loan, then most banks charge a pre-payment fee which could vary from between 2-5% of the amount being prepaid. This can be an important consideration since personal loans have a high interest rate and one should try and repay the loan quicker if possible.
*      Other charges such as late payment fees, documentation charges etc.

<b>What Loan duration should you opt for</b>

While some banks offer personal loans up to duration of 7 years, most restrict the duration of the loan to between 3-5 years. What duration you should opt for should be a balanced view taking into account the following principles:

*      Minimising interest costs: The lower the duration of the loan, the lower are your interest costs.
*      Affordability: Lower duration, however, means a higher EMI which you may or may not be able to afford as a cash outflow every month.

<b>The importance of timely repayments, credit score and CIBIL</b>

Having taken a loan, it is imperative that you make all payments that are due in a timely manner. Your credit and repayment history is maintained by the Credit Information Bureau of India Limited (CIBIL). This information is shared with CIBIL members as ‘Credit Information Reports (CIR)’ for them to ascertain whether or not to provide a loan, credit or credit card to a customer and if they would want to provide these products at a differential pricing i.e. at more favourable terms for a customer with a high credit score. A good credit history without any defaults can help you build a good credit score that can help you with your credit needs at a later time in terms of better rates and faster approvals.

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(c) TM | Magi Research and Consultants Pvt. Ltd. 2010

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