If you are strapped for cash or dreaming of a once-in-a-lifetime foreign vacation, a personal loan may help in closing your gap for funds. Irrespective of the income bracket you fall in, you can benefit from a personal loan for a wide range of needs. The versatility of the debt lies in the fact that it can fund a wedding, help in the completion of a home improvement project, cover educational expenses, or even consolidate your other debts.
Banks in India offer personal loans at attractive interest rates and tenures, and there is usually a torrent of offers during the festive period. However, before you are magnetized by these offers and sign on the dotted line, you should be aware of a few intricacies associated with this unsecured debt. Listed below are the top 7 things to bear in mind before you opt for a personal loan:
Check your credit score - It is advisable to examine your credit report before you initiate the process of applying for a personal loan. You can get a concise version of your credit report through neutral financial websites, absolutely free of cost. The credit report has the history of all your loans, your repayment efficiency, income details, occupation, etc. If you have a clear-cut picture of the issues in your credit report, you can work on improving your score before applying for credit. In case you have a good credit score, you can negotiate for a better deal on interest rate with the lender.
- Keep the EMIs affordable - Financial advisors are of the opinion that a borrower should not have a personal loan EMI that exceeds 10% of his/her net monthly income. Also, your contributions each month towards the repayment of all loans should not exceed 50% of the net income. Going above this loan-to-income ratio can actually drain your monthly income to the point where you will be left to survive from paycheck to paycheck. Retirement savings will be affected first in such a scenario.
Every working professional should ideally have a robust financial strategy that helps in setting aside a specific amount regularly towards his/her retirement corpus. In case he/she is not disciplined enough to make this investment independently, he/she can purchase a life insurance scheme with retirement benefits.
Choose shorter tenures - In order to understand how personal loans function, you just need to master a few basic concepts on the relationship between loan EMIs and tenures. The thumb rule is that the longer the tenure, the lower will be the monthly EMI. This also means that the total interest that the borrower pays towards the loan will be higher. However, most borrowers opt for longer tenures primarily due to the underlying tax benefits and comfortable monthly repayment figures. But you should understand that this will only lead you into paying a huge interest on the debt.
Repay faster - As indicated above, it is advisable to repay the loan faster so that you can avoid paying a large amount as interest. One way in which you can do so is by increasing the EMI each year to mirror the rise in your income. Even a 10% increase in EMI can cut short the loan tenure by a significant amount. Paying an extra EMI each year is another option. You can also consider prepayment of the loan when you get a windfall, a well-deserved bonus at work, or even an unexpected tax refund. But remember that it is more beneficial to make prepayments in the early years of the loan repayment period.
Read the loan documents - The financial jargon in loan agreements make the process of reading and understanding these documents a little cumbersome. However, it is crucial that you are aware of the details in the fine print, specifically the charges. Read through the terms and conditions carefully, and take the help of a financial advisor in case you need assistance in understanding the terminology.
Insure your loans - No doubt that taking a loan is one of the most appropriate ways in which a salaried individual can accomplish his/her life’s goals. But what happens if the borrower faces death before the loan is repaid? This is where insurance on loans come into the picture. If you insure your personal loan, your family will be provided the much-needed financial assistance in the unprecedented event of your death. This is particularly useful for borrowers who deal with large business loans and the like. You can opt for a reducing cover term plan or a regular term insurance policy to protect the debt repayments.
Do not dip into your retirement savings - Many Indian parents are willing to sacrifice their retirement savings to fund the education of their children. This is a poor move as far as your finances are concerned. Remember that education loans with tax benefits are easily available today to fund the higher education needs of your child. But there is no replacement for your retirement savings. So safeguard your nest egg and do not dip into it at any cost.
Consolidate debts - You can consider consolidating your existing loans under one low-cost secured loan. This will bring down the interest rates by a great deal. But it is crucial to manage the secured loan effectively, or it may jeopardize the collateral.
Shift lenders if required - It is often seen that some banks offer lower interest rates on personal loans to new customers, while the existing customers continue to pay higher interests. You should always look out for the offers from different lenders and assess whether it makes more sense to switch banks. In line with this, it is important to consider the processing and switching charges that come into play. Like prepayments, it is always better to switch lenders at the beginning of the loan tenure.
On a final note, it is not advisable to take a personal loan to fund purposes that do not yield any finite benefits. An example of this would be taking a loan to finance a wedding. You should remember that such an act would only result in the couple starting their life together with a pile of debts. Hence, you should discipline yourself to approach a lender only to finance the purchase of assets that increment in value or provide you returns in the long run.
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