Taking a personal loan? 10 mistakes to avoid

Personal loans could well be the answer to many immediate financial needs. Whether it's a home renovation, education expenses or medical emergency, a personal loan could be the ideal solution. However, with the myriad loans available in the market, each claiming its competency, how do you ensure you do not end up in a bad debt or a huge loan liability?

InvestmentYogi lists some of the pitfalls one must avoid to ensure that the burden of the loan doesn't burn one's pocket. 

Taking a personal loan?
A personal loan is generally borrowed for personal unforeseen cash requirements and is granted on the basis of the borrower's credit records, ability to repay and his integrity.

Most loans offered are 'unsecure', meaning that there's no requirement of any collateral. This is one of the reasons why most personal loans quote high interest rates between 12 per cent pa to maybe even 30 per cent pa. However, almost all lending institutions seek a guarantor for the loan. Most financial planners, thus, advise against personal loans in one's balance sheet.

If you are deciding on a personal loan, it pays to ask yourself the following questions.

• How essential is the expense, or could it be avoided?
• Is the expense an urgent one, or could it be postponed?
• Do I really need a loan for the expense or can I manage with my cash flows?
• Are there alternatives such as borrowing from friends, relatives or other means? Is a personal loan absolutely necessary?

If after these questions, you still must go in for a personal loan, keep in mind the following points...

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Many borrowers overstretch their finances by borrowing beyond their affordability. The outcome could be a financial crisis. Borrowers could find it difficult to meet important daily expenses. It could even lead to default in payments resulting in a bad credit record, and eventually even a debt trap.

Thus, be wise and accept a loan only if you can afford to repay the regular EMIs and also manage your monthly expenses.

Be honest about your past credit record
Almost all lenders grant personal loans on the basis of a borrower's credit record. Be aware of your credit worthiness, and maintain a good record of all liabilities.

Be honest about your past credit record. Any missed payments in the past should not be hidden from lenders. Banks take false information incidents very seriously.

Existing loan EMIs or other financial obligations should be disclosed to the lender. It is on the basis of your overall financial condition that the loan is being sanctioned.

By hiding information, you may end up with a higher personal loan, but there could be a probability that you may not afford the loan, considering your commitments to other existing liabilities.

Do a market survey
Before you decide on a lender, it pays to do a bit of study on what other lenders have to offer. Do a comparison of charges, prepayment clauses and interest rates.

Do negotiate on the charges for application processing and documentation.

If you aren't getting the loan amount you desire from the lender, avoid seeking any further amount from a second lender. Eventually it is your loan liability which is collectively increasing. 

Of course, by doing this your immediate cash requirement is fulfilled, but such a large liability would only make you stretch beyond your capacity to repay. With two or three EMIs, and rising cost of living, a large collective loan liability is nothing but a burden.

Do not sign blank documents
Many a time, banks send executives to help borrowers through the documentation process. Do not leave a blank signed application for the executive to fill up. Fill up the application yourself, and familiarise yourself with what is being asked from you and what you will be offered.

Read the loan agreement thoroughly. Be aware of the interest rate being charged, the processing fee and other hidden charges.

Be very clear about, the loan pre-closure clauses. Banks generally do not encourage loan prepayment in the first six months and the penalty charged could be an exorbitant amount.

Choose the EMI and loan tenure
Choose an EMI that can be managed comfortably each month. As a matter of fact, in the long run, a higher EMI with a shorter tenure works more cost-effective than a lower EMI with a longer tenure.

However in this process ensure that your monthly budget is not strained.

Approach your regular banker for the loan, who is already be familiar with your credit worthiness. It will enable quick processing and easy disbursement of the loan.

It would probably also be easier for you to negotiate on the charges.

Maintain statements and accurate records
It is very important to safely maintain all records of loan disbursed and payments made. All details of negotiated interest, processing fees, waivers etc need to be on record, as banks sometimes charge a fee for additional statements and agreement copies.

Points to ponder
A personal loan addresses immediate cash flow needs, with the flexibility to use the money for personal household requirements. Having said this, one must keep in mind that due to the high rate of interest quoted by lenders on such loans, it is best to take them only if the expenditure is urgent and cannot be postponed.

Also, in the present day scenario, one should consider various other alternatives to a personal loan such as loan against fixed deposit, gold, shares etc. It pays to weigh one's requirement with the alternatives available and the effective cost of the loan before making a decision.