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10 Mistakes to Avoid While Taking Personal Loans

Published: Tuesday, April 19, 2011, 18:30 [IST]

10 Mistakes to Avoid While Taking Personal Loans

Personal loans could well be the answer to many immediate financial needs. Whether it"s a home renovation, education expenses or medical emergency, a personal loan may appeal as the ideal solution. However, with the myriad of loans available in the market, each claiming its competency, how do you ensure that you do not end up in a bad debt or a huge loan liability? InvestmentYogi brings out the pitfalls one must avoid in a personal loan to ensure that the burden of the loan doesn"t burn one"s pocket.

Taking a Personal Loan?

A personal loan is generally borrowed for personal unforeseen cash requirements and it is granted on the basis of the borrower"s credit records, ability to repay and his integrity.

Personal loans quote high interest rates between 12% p.a. to maybe even 30% p.a. Worst is that almost all lending institutions seek a guarantor for the loan. Most financial planners, thus, advice against personal loans in one"s balance sheet.

If you are deciding on a personal loan, it pays to ask yourself the following questions.

- How essential is the expense, or could it be avoided? - Is the expense an urgent one, or could it be postponed? - Do I really need a loan for the expense or can I manage with my cash flows? - Are there alternatives such as borrowing from friends, relatives, or other means? - Is a personal loan absolutely necessary?

After reflecting on these questions, if you still must go in for a personal loan, keep in mind the following points.

Mistakes to Avoid - What should be and should not be done

1) Do not borrow beyond your repayment capacity - Many borrowers overstretch their finances by borrowing beyond their affordability. The outcome could be a financial crisis. Borrowers could find it difficult to meet important daily expenses. It could even lead to default in payments resulting in a bad credit record, or it could even lead to a debt trap. Thus, be wise and accept a loan only if you could afford to repay the regular EMIs and also manage your monthly expenses.

2) Past Credit Record - Almost all lenders grant personal loans on the basis of borrower"s credit record. Be aware of your credit worthiness, and maintain a good record of all liabilities. Be honest about your past credit records. Any missed payments in the past should not be hidden from lenders. Banks take false information incidents very seriously.

3) Disclosing existing loan details - Existing loan EMI"s or other financial obligations should be disclosed to the lender. It is on the basis of your overall financial condition that the loan is being sanctioned. By hiding information, you may end up with a higher personal loan, but there could be a probability that you may not afford the loan considering your commitments to other existing liabilities.

4) Do a market survey - Before you decide on a lender, it pays to do a bit of study on what other lenders have to offer. Do a comparison of charges, prepayment clauses and interest rates. Do negotiate on the charges for application processing and documentation.

5) Avoid taking multiple personal loans - If you aren"t getting the loan amount you desire from the lender, avoid seeking any further amount from a second lender. Eventually it is your loan liability which is collectively increasing. Of course, by doing this your immediate cash requirement is fulfilled, but such a large liability would only make you overstretch beyond your capacity to repay. With two or three EMIs, and rising cost of living, a large collective loan liability is nothing but a burden.

6) Do not sign blank documents - Many a times, banks send executives to help borrowers through the documentation process. Do not leave a blank signed application for the executive to fill up. Fill up the application by yourself, and familiarize yourself with what is being asked from you and what you would be offered.

7) Reading the fine print - Read the loan agreement thoroughly. Be aware of the interest rate being charged, the processing fee and other hidden charges. Be very clear about, the loan pre-closure clauses. Banks generally do not encourage a loan prepayment and charge an exorbitant amount as penalty.

8) Choosing the EMI and loan tenure - Choose an EMI that could be managed comfortably each month. As a matter of fact, in the long run, a higher EMI with a shorter tenure works more cost effective than a lower EMI with a longer tenure. However in this process ensure that your monthly budget is not strained.

9) Choosing your banker - Approach your regular banker for the loan, who is already familiar with your credit worthiness. It would enable quick processing and easy disbursement of the loan. It can also be easier for you to negotiate on the charges.

10) Maintain statements and accurate records - It is very important to safely maintain all records of loan disbursed and payments made. All details of negotiated interest, processing fees, waivers etc. need to be on record, as banks sometimes charge a fee for additional statements and agreement copies.

Points to Ponder

A personal loan addresses immediate cash flow needs, with a flexibility to use the money for personal household requirements. Having said this, one must keep in mind that due to the high rate of interest quoted by lenders on such loans, it is best to take them only if the expenditure is urgent and cannot be postponed.

Also, in the present day scenario, one should consider various other alternatives to a personal loan such as loan against fixed deposit, gold, shares etc. It pays to weigh one"s requirement with the alternatives available and the effective cost of the loan before making a decision.

Courtesy: InvestmentYogi

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