Personal loan: avoid 5 mistakes

Personal loan is often the preferred credit option for those seeking quick credit access with minimal documentation and no collateral. However, this ease of access leads many borrowers to overlook crucial aspects, leading to higher interest costs, unexpected charges or even a debt trap. Here are five common mistakes loan applicants should avoid:

Not getting credit report early

Your credit score is one of the first filters lenders would use to evaluate creditworthiness. Those with higher credit scores usually have better chances of loan approval. Many lenders also use credit scores to set interest rates of the loan applicants, with those having higher scores being offered lower rates for the loans. Thus, always fetch your credit report before making the loan application as any error or outdated information in credit report can reduce credit score and thereby, reduce loan approval chances. If you notice any error(s), report them to the concerned credit bureau(s) and the lender for rectification. A rectified credit report can lead to higher credit score and thereby, increase your loan approval chances at lower interest rates.

Not comparing loan offers

The interest rates offered to the same applicant can vary widely across lenders depending on cost of funds and credit risk assessment of the loan applicant. Some lenders also offer loans at preferential interest rates to existing customers. Thus, those planning to avail the loans should compare loan offers from as many lenders as possible.

They should begin the search by approaching banks and NBFCs with which they already have existing deposit and/or loan/credit card relationships. This should be followed by visiting online financial marketplaces to view the loan options of other lenders.

Then, an applicant should opt for the lender that charges the lowest interest rate for the desired loan amount with the optimal tenure.

Ignoring ‘optimal’ repayment

Lenders usually prefer loan applicants whose monthly EMI obligations, including that of the proposed loan, do not exceed 50-60% of the monthly income. However, even if it does not, the optimal loan EMI would be the one on which you incur the lowest interest cost without adversely impacting unavoidable expenses and monthly contributions for crucial financial goals. You should use online EMI calculators to fix the optimal loan EMI after factoring in income/other financial commitments.

Ignoring loan options

Just like personal loans, secured loan options like top-up home loans, loan against property (LAP), gold loans and loan against securities do not have any end-usage restrictions.

Being secured in nature, these loans usually have lower interest rates than personal loans. Top-up home loans and LAP also offer longer tenures than personal loans, which further increases EMI affordability and overall loan amount eligibility for the borrowers.

On the flip side, the turnaround time (TAT) for LAP disbursal can be much higher than that of personal loans, while gold loan and loan against securities have similar TATs.

Thus, existing home loan borrowers or those having adequate gold, property or investments to pledge should explore suitable secured loan alternatives and disbursal TAT before making a personal loan application.

Ignoring emergency fund

Financial emergencies or loss of income due to job loss, disability, illness, etc. lead many borrowers to default on EMIs. Such repayment failures would not only incur hefty penalties, it also reduces one’s credit score and thereby, his or her future loan/credit card eligibility. The best way to avoid such scenarios is to increase the size of your emergency fund by at least six months’ worth of your personal loan EMI.

(The writer is CEO of Paisabazaar)