When you should take a personal loan – and when you definitely shouldn’t
Personal loans are increasingly being seen as a quick fix for cash flow needs. They offer easy access to funds without the need for any collateral. Currently the interest rates on personal loans start from around 9.99% per annum for reputable credit score borrowers and can go above 20% for riskier borrowers.
With various lenders now providing more flexible tenures and faster disbursals many individuals are wondering if now is a good time to borrow.
Still, just because a personal loan is easy to access due to the ongoing digital revolution in lending, it doesn’t mean it should be taken lightly. Understanding when it makes sense and when it doesn’t, is key to borrowing smartly.
When should you take out a personal loan?
You should consider taking a personal loan only when the purpose aligns with your financial goals. These can include:
- Debt consolidation to bring down your overall interest burden.
- Medical emergencies, such as surgeries, invasive operations or accidents.
- Educational expenses that support your or your child’s future.
- Necessary home repairs, renovation or improvements
For such situations a personal loan can be a helpful tool. Still, one should always pay close attention to the entire loan tenure. Given longer durations can bring down monthly personal loan EMIs they also increase the total interest outgo, thus making the loan more expensive over time.
When is a personal loan not a good idea?
It is important to keep in mind that personal loans carry one of the highest interest rates among retail credit products. Using them for non essential or lifestyle driven expenses such as weddings, vacations or gadgets is generally not considered a prudent financial decision.
They also come with additional charges such as processing fees, documentation charges along with prepayment penalties. In case your credit score is low or your income is irregular, the loan may come at a significantly higher cost or may not be approved at all.
Amit Suri, founder of AUM Wealth and a fund distributor, advises “Personal loans carry the highest interest rates so they should ideally be a last resort. It’s best to avoid taking on debt, whether personal loans or credit cards, for lifestyle expenses. If borrowing becomes unavoidable, then it would be better to assess repayment capacity, compare rates across lenders, and review prepayment terms carefully.”
“While personal loans can help during emergencies, individuals should plan for them in advance through emergency funds or having adequate insurance coverage. And it is very important to read the fine print before taking a personal loan,” Suri added.
Key considerations before taking a personal loan
Even with lucrative offers the terms of the loan and your own financial profile decide whether the deal is right for you or not. Hence before applying consider:
- Credit score: A score above 720 gives you access to lower interest rates.
- Income stability: Financial institutions prefer applicants with a verifiable income.
- Debt to income ratio: High existing debt can reduce your loan approval chances.
- Prepayment terms: Some lenders charge penalties if you repay the loan early.
- Processing fees: These may range from 1% to 3% of the loan amount.
It is also prudent to understand the overall lending climate. Banks are becoming careful about unsecured loans due to rising defaults, and this could make approvals stricter, especially for applicants with lower scores or higher existing liabilities.
Disclaimer: Mint has a tie-up with fintechs for providing credit; you will need to share your information if you apply. These tie-ups do not influence our editorial content. This article is intended to educate and spread awareness about credit needs like loans, credit cards, and credit scores. Mint does not promote or encourage taking credit, as it comes with risks such as high interest rates and hidden charges. Please consult a certified financial advisor before making any credit decision.
