When a personal loan is a bad idea: Know the risks before you borrow

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Personal loans are among the easiest to get nowadays. With minimal paperwork required, instant disbursal, and no requirement of collateral, they can be very useful in unforeseen situations or for big-ticket buys. But they have high interest rates as well, stringent repayment terms, and debt traps if not approached with care. Knowing when not to apply for a personal loan can save you from falling into long-term financial difficulties.

Don't use a personal loan for frivolous spending

Spending a personal loan on vacation outings, premium gadgets, or lifestyle upgrades is not the best of ideas. While these spending can tide you over in the short run, they could land you with long-term loan repayment commitments. Personal loan EMIs are typically 1 to 5 years and can hurt your financial independence when you are stuck repaying something that is not generating any value or returns.

Steer clear of it when you are already over-leveraged

If you already have outstanding loans to settle—such as a home loan, vehicle loan, or credit card EMIs—you might be pushing your finances too hard by taking another personal loan. Your credit utilization also increases, hurting your credit score. If you default, your overall credibility suffers, and you might find it difficult to take loans in the future.

Think twice if you don't have a regular income

Personal loans require a fixed periodic payment. If your job is uncertain and your income unpredictable—for example, if you’re freelancing or self-employment in business—it is unwise to start another EMI. It can attract charges, legal notices, and collection calls in case you default. Lenders are tougher on non-payment of personal loans since these loans are not secured.

When alternatives are less expensive or safer

Before taking a personal loan, check whether cheaper options are available. For instance, top-up loans on an existing home loan, gold loan, or fixed deposit or insurance policy loans are generally less expensive. Even taking a loan from a friend or relative, if you are sure you can repay on time, may be better than getting into a high-interest bind.

Find structured financial support

If you are confronted with a medical crisis or family emergency, first check whether your health insurance, employer-sponsored benefit, or government welfare scheme will cover some part of the cost. Several hospitals and institutions also offer EMI-based financing schemes at zero or sub-zero interest rates. Your personal loan must be the last resort.

Lend only if repayment is certain

Personal loans can prove to be a good choice, provided they are used wisely, such as to consolidate high-cost debt or to cover urgent, unavoidable expenditures. But borrowing to cover discretionary spending, without a strategy to repay, or at the last minute, will land you in deeper trouble. Always take into account your monthly financial burden, compare around, and be sure that you can pay your EMIs before signing on the loan document.

FAQs

Q1. What is the standard interest rate on personal loans in India?

Interest rates are extremely varied, between 10% and 24% annually, and also based on the bank, your income profile and past credit history.

Q2. Am I able to prepay a personal loan if I change my mind?

Yes, the majority of banks allow prepayment after a minimum lock-in period of 6–12 months but also impose prepayment charges. Carefully read the terms of the loan before applying.

Q3. Will a personal loan reduce my credit score?

Yes. A personal loan increases your exposure. Timely payment will raise your score, and late payment of the EMI or defaulting will hurt it badly.