Personal loan: What you need to understand about it?

This is a crucial but probably the most misunderstood aspect about personal loans. Since it’s not attached to any asset, a personal loan can be utilized for anything. It has been slowly becoming a lifestyle enhancement loan for buying expensive items like car, TV, fridge and even a house. In recent times this loan has been utilised most for vacations at exotic places and throwing parties at specific occasions. There have been many instances wherein a personal loan is availed to help friends/relatives. Look at all these options and it comes out that personal loan is being used more for lifestyle than for need.

The cons

There is nothing wrong in using a personal loan when you are cash starved and there is a genuine need. But the problem arises when the loan is availed without realizing its impact on your own finances. Youngsters fail to understand that a loan cannot be availed based on expected future income. Going to exotic places is a dream but when you avail a loan for it, it shows that the budget was never within your means and you didn’t plan for it. Similarly, lifestyle expenditure through loan is not what your finances allowed and you haven't planned for it. Helping friends or relatives is fine but what if the person you are helping fails to repay you? Many fail to understand this. The repayment of such loans is based on repayment capacity of your friend and not yours – if he fails you have to repay it. Otherwise you are saddled with bad debt. All these are reasons good enough for youngsters to avoid personal loan if the end use is lifestyle.

The Good

But there is a good side of a personal loan. It helps you to save money by repaying high cost credit card debts and fall upon if there is a cash crunch during emergency. Credit cards are most disastrous if not used properly. Many a times when youngsters need money immediately then they swipe their credit card or withdraw from ATM without understanding the billing cycle. This leads them to bad financial situation since the rates are too high on cash withdrawal from credit card and they are not in a position to repay it immediately. Wait for a few days and the amount rises substantially as the interest is charged on a daily basis. Rather a personal loan at this juncture may help if the funds needed are for genuine reasons and not for lifestyle. Personal loan can help in coming out from high interest credit card debt which otherwise is difficult when only minimum amount is repaid. Most youngsters do it without understanding the difference between minimum amount and total due amount due on credit card bill. The last is the emergency situation where the funds are short to deal with. All these are instances where personal loan does help but one need to understand this loan completely.

Should you go for it?

The best foot forward in money matters is to start saving money as you earn it. Today, debit cards too help in many ways and give benefits equivalent to credit cards except credit period. If you just took your first job, do not go for loans immediately. Instead spend time in building a habit of living within your means. Also, bad loans in the start of your career will impact your CIBIL credit score lowering your possibility of availing loans when you actually need it. Personal loans may stand good at specific situations, only if you can understand the end use. Personal loans if used in reckless manner can destroy your financial matters. The only recourse to save yourself from it is to know about your finances and seek the advice of professionals where you are less aware.

(The writer is independent financial advisor.)