Personal loans are essential when you need funds for emergencies, medical expenses, or even a quick getaway with family. They are relatively easy to access and offer quick disbursements once the necessary formalities are completed. However, while securing the loan is simple, managing the repayment process efficiently is equally crucial. If not handled properly, personal loans can lead to financial strain, impacting your budget, credit score, and overall financial health.
Here’s a detailed guide on common mistakes to avoid when taking out a personal loan, ensuring smooth repayment and peace of mind.
Opting for an Unaffordable EMI
One of the biggest mistakes people make when applying for a personal loan is choosing an EMI (Equated Monthly Installment) that’s too high for their budget. While paying off the loan faster may seem appealing, opting for a shorter tenure and higher EMI can cause unnecessary financial strain. A higher EMI may affect your monthly budget, leaving you less flexibility to manage other expenses.
To avoid this mistake, constantly assess your monthly income and expenses before committing to a loan. Choose a loan tenure that aligns with your financial situation and an EMI you can afford. This will help you maintain financial stability while still fulfilling repayment obligations.
Choosing a Longer Tenure with a Lower EMI
Conversely, some may choose a longer tenure to reduce the EMI burden. While this may lower your monthly payment, it comes at the cost of paying higher interest over the loan’s duration. A loan with a long tenure and a small EMI might seem easy to manage initially, but you’ll pay more in the long run.
It’s essential to strike a balance between the tenure and the EMI. Opt for a tenure that is not too long, thereby reducing your interest payment and ensuring that the EMI is not too high to become unmanageable. Carefully calculate the interest cost and loan tenure to ensure you aren’t paying more than necessary.
Neglecting to Compare Interest Rates and Loan Features
Not comparing interest rates and other loan features from different lenders is a common mistake many borrowers make. Each financial institution offers different terms, fees, and interest rates. By not shopping around, you might end up with a loan that isn’t the best deal for your needs.
Before committing to a personal loan, compare offerings from various banks and Non-Banking Financial Companies (NBFCs). Pay attention to interest rates, processing fees, foreclosure charges, and loan amount eligibility. Also, repayment flexibility and customer service should be considered. Using online comparison tools can help you assess your options quickly.
Overlooking Loan Charges and Fees
When taking out a personal loan, it’s essential to understand all the associated fees and charges. Banks may only sometimes advertise these fees upfront, but they can significantly impact your loan repayment. Common charges include:
- Loan Processing Fee: This is usually a percentage of the loan amount and can be deducted from the disbursed loan or paid upfront.
- EMI Default Penalty: Missing or delaying an EMI can incur a penalty, increasing your total loan cost.
- Statement Fees: A fee may be charged if you require hard copies of your repayment statements.
- Foreclosure Charges: If you decide to repay the loan early, the bank might charge a penalty, typically 1-4% of the outstanding amount.
- Statutory Fees: Stamp duties, GST, and other legal charges may apply.
To avoid surprises, read the loan agreement carefully and be aware of all potential charges before signing.
Not Maintaining Sufficient Balance in the Repayment Account
One of the most critical mistakes you can make is not maintaining an adequate balance in your EMI repayment account. Missing an EMI due to insufficient funds will result in penalties and may harm your credit score. In extreme cases, your account could be classified as a Non-Performing Asset (NPA), significantly hurting your ability to secure future loans.
It’s advisable to always keep at least one EMI’s worth of balance in your repayment account. A buffer will ensure you can cover unforeseen expenses and avoid bouncing an EMI. Set up an automated system to transfer funds into the EMI account to ensure timely payments.
Not Considering Prepayment or Foreclosure Options
If you cannot repay your loan early, consider prepayment or foreclosure. By paying off the loan earlier than scheduled, you can save on interest payments and become debt-free sooner. However, some lenders charge a fee for early repayment, so be sure to check whether these charges are worth the savings in interest.
Before opting for prepayment, consider whether the fee outweighs the benefits. Early repayment may be a smart move if the loan’s interest rate is higher than what you could earn from other investments.
Applying for Multiple Loans Simultaneously
If you urgently need funds, applying for personal loans with multiple lenders is a good idea to increase your chances of approval. However, this is a dangerous approach. When various banks or lenders see numerous loan applications on your credit report in a short period, it can give the impression that you are desperate for credit, which could lead to your application being rejected.
Instead, apply to one lender at a time. If the application is declined, improve your eligibility before using it elsewhere. Multiple loan applications can negatively impact your credit score and make it easier to get approved.
Conclusion
A personal loan can be a great financial solution for handling emergencies, purchasing, or consolidating debt. However, avoiding the mistakes mentioned above can make a significant difference in ensuring that your loan remains a manageable part of your financial journey. Carefully assess your loan options, understand the terms and charges, and maintain a healthy balance in your repayment account to ensure smooth repayment and financial peace of mind.