Factors to consider while taking a personal loan

Personal loans rescue you out of an emergency situation. They are unsecured loans that get processed quickly and help you meet your immediate financial needs. However before you take on this debt there are some important things that you must consider.

Look for the best deal- You should consider the lender who offers you the lowest interest rate as it reduces the cost of borrowing. Call the customer care of various banks to find out about the prevailing personal loan interest rates. If you wish to service the loan for a longer duration to reduce the EMI burden you can consider the lender who gives you the flexibility of a longer duration.

Do not compare apples with oranges Do not simply go for the lowest interest rate. Consider whether the loan is being offered at flat interest rate or reducing balance rate. In case of flat rate the interest is calculated on the total loan amount without considering the amount that is already paid. While the reducing balance interest is calculated on the outstanding loan balance. When you compare the personal loan interest rates offered by different banks do not mix the two. The flat rate is usually lower than the reducing rate but usually works out to be expensive.

Consider other charges-

Processing fees- Interest rate is not the only thing that needs to be considered while taking a loan. Other charges like the processing fee add up to the total cost of the loan. Typically banks charge 1-2% of the principal amount as the processing fee. Assess the all-inclusive cost while comparing the different options.

Prepayment penalty- If you require a personal loan just to tide over a short term cash flow crunch and wish to pay it back as soon as the cash flow improves, you should be looking at the term “no prepayment penalty” in the terms and conditions. But usually banks charge 2-5% of the outstanding loan amount as a prepayment fee if the borrower decides to foreclose the loan. This is a tool they use to ensure that the borrower stays with the loan and bears the full interest cost. But if you intend to take the loan only for a short period then consider the option where the prepayment penalty is the least.

Late payments- Before signing the agreement find out about the charges that the bank levies in case you miss an EMI payment. This will avoid unexpected setbacks and future surprises in case you are not able to pay your dues on time.

Settle your dues and check your CIBIL Score- Your CIBIL score plays an important role in your application approval process. Even the personal loan interest rate that you qualify for is determined on the basis of the CIBIL score. Clear all your pending credit card dues and ensure that it is reflected in your credit history before your application is processed. Check your CIBIL score to understand whether you can bargain for a lower interest rate or not.

Borrow what you need, not what you are eligible for- Sometimes banks try to convince you to borrow a greater sum than what you actually need. Do not fall for their sales pitch and borrow only the amount you need. After all it is the most expensive form of credit and you would not want to pay interest on the money that you don’t actually need.

Factor in your repayment ability- Before signing up for a loan, make ensure that you have the capacity to service the EMIs. Do an honest assessment of your repayment ability and decide on a realistic amount that you can afford to borrow. Failure to pay your dues on time will not only attract penalties but also ruin your credit score.

Reconsider your decision- Personal loan is a very expensive form of debt that should be used only when absolutely needed. Though it is easy to apply for one in case of a cash crunch you should try to avoid it as far as possible. While it is justified to use it in case of an emergency it surely doesn’t make sense if you want to use it to go on a vacation or buy stocks. Even if you have some visibility of future cash flows, unforeseen events like an accident, job loss etc. may lower your income making it difficult for you pay the EMIs. So reconsider your decision before signing on the dotted line.

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