A personal loan is an unsecured loan offered by banks and non-banking financial companies (NBFCs). These are unsecured because a borrower is not required to pledge any asset—property, jewelry or car—to get the loan. For this reason, personal loans come with a higher interest rate compared with secured loans, such as a home or car loan.
A personal loan comes in handy in case of a financial emergency as you can borrow the required amount in 12-48 hours from an NBFC by simply submitting income-related and personal information documents. Banks can take up to seven days to process the loan request. What more? Personal loans come with no strings attached as the lender does not monitor its use.
While personal loans give easy access to credit, they can also be a recipe for financial disaster, if not managed prudently. Here are the most common mistakes you should avoid when applying for a personal loan.
Reason for borrowing
Ask experts and they will tell you that personal loans should be the last resort. Before applying for the loan, determine whether you are borrowing for an unavoidable need, say medical emergency, or just a lifestyle related expense, such as a foreign vacation or high-end smartphone.
One should avoid borrowing for personal needs. The very nature of personal loans being easily available credit can push you into a debt spiral as it gives a wrong illusion of higher affordability.
Be wary of the costs
Personal loans are the costliest forms of loans with an interest rate of 18-24 per cent. But, that’s not all. The borrower also has to pay a processing fee of 1-3 per cent towards the costs incurred by the lender in processing the loan application. Some personal loans also come with a pre-payment charge of 2-5 per cent. This is usually the case with short-term loans of less than 12 months.
Take note that processing fee and prepayment charges, if any, are not sacrosanct. You should negotiate for the lowest rate possible to reduce your overall cost.
Long tenure with lower EMI amount
Typically, longer the tenure, lower the interest rate. Some lenders also offer a ‘cheap’ flat rate of interest if you borrow for a longer term of 15 to 18 months. While long-term loans with smaller EMIs may seem like an easy way of repayment, the absolute payment outgo will be more over the tenure.
Short-term personal loans are more cost-effective compared with long-term loans. Having said that, don’t ignore your cash-flow management as EMI amount of a short-term loan is much higher. You should select the repayment tenure as per your repayment capacity keeping in mind your monthly budget.
Read the fineprint
It is a tendency for mobile users to scroll through the terms and conditions column without reading it thoroughly and blindly tick the acceptance box. This practice can cost you later as all the details related to prepayment and processing charges are mentioned in the fineprint