Personal loans can be useful in your time of need. Personal loans can fulfil your short-term desires. In a nutshell, some extra cash can get you out of a jam.
Sometimes, people take loans without hesitation and just ignore some rules that no one comes to tell them before taking a personal loan.
While taking that extra cash you also take up the responsibility of paying it back. And in our experience, the payback terms can be a bitter pill to swallow.
It is your duty to ensure that terms are easy and reasonable. Hence, here are 7 rules which would come in handy when you apply for your next personal loans.
Adhere to these rules and you will never get into trouble by overleveraging yourself (taking a loan more than you can return). So here it comes.
1. Borrow Less Than What You Can Repay
The best way to make sure that you do not burden yourself is to never take-on a large EMI.
Always take a loan that you can easily repay. It is important that the EMI is less than 15% of your net monthly income (the money you get in your account every month).
Your other financial goals will seriously suffer if your monthly EMI is greater than 15%. Your savings might be delayed for a longer period than you expect.
The high debt burden is a downward spiral with no way to recover from it. Too much debt will keep your net worth negative for years.
EMIs can dominate your life – check out our blog on signs that confirm EMI’s dominance.
It is extremely important to save yourself from this blunder.
2. Never Take A Personal Loan To Invest
First Rule of investing – never invest with borrowed money.
The most basic rule is that do not borrow money to invest.
ELSS Mutual Funds are tax-saving instruments and you might get tempted to borrow and invest in them. But do not forget, ELSS is linked to equity markets. Their fate is similar to equity stocks investing.
And equity markets are so volatile that you might lose the investment itself. In a market crash, you will lose your investment and will have to pay a monthly EMI for the personal loan as well.
So, it is a very very bad idea to invest with borrowed money. Especially personal loans.
3. Pay on time and regularly
You being on time will work wonders for. On the other hand, if you do not pay on time your credit score takes a hit.
If you miss on your personal loan EMI, then the lender can take over the collateral and sell it. If your personal loan is unsecured then the lender can drag you to a court which can lead to an even bigger loss.
One late payment will do much more damage than 100 timely EMI payments will repair.
It is advisable to sell some investments to repay if you think you can not make an EMI payment on time. Never miss on a personal loan EMI.
If you think that paying back can be a problem or if you feel the EMI is a huge burden, then do not take a personal loan. Remember Rule 1 do not take loans whose EMI will be greater than 15% of your net monthly income.
4. Shop for lower interest rates
Once you decide that you need a personal loan, then the next step is to shop for the best interest rate you can get. And by the best interest rate, we mean low-interest personal loan.
It is a no-brainer to always borrow money at a lower interest. If you take a loan with high-interest rates you will be paying extra money for no good reason.
The lower the interest charged on your personal loan the easier it gets to manage EMIs and paying them back. Check out the interest rate comparison – Credit Cards or Personal Loan.
A high-interest loan will deprive yourself of saving money. And if you cannot save money then you can not invest. Finally, if you do not invest, then you set yourself up for failure.
Your opportunity cost will always be high as you will have to let-go of any wealth creation chances you might get.
5. Be aware of 0% EMIs or No Cost EMIs.
In 2013, the Reserve Bank of India released a circular regarding No-Cost EMIs. In that circular, it was mentioned that a 0% ROI loan is non-existent. And lenders camouflage the interest component as processing fees.
All we can make out of this statement by the RBI is that most 0% EMIs are just alluring factors to trap people. By saying that no interest will be charged, it gets easier to market loans.
The lenders hide their interest income as processing fees and they make a ton of money as many people fall in this pit.
However, online retailers like Amazon and Flipkart bare the processing fees and interest. They give a discount or instant cashback on a few purchases. Not on all. Check before buying.
Still, be aware of the tricks lenders use to trap you. Be cautious about No-Cost EMIs. No cost EMI is not really ‘no cost’.
6. Look for Option to Foreclose at Low Charges
Foreclosure charges are charged when you repay the loan amount earlier than written in the loan agreement. This prevents lenders from earning what they had expected.
For instance, suppose that you took a loan for 12 months but pay it back in 10 months. Then the lender does not get the interest for 2 months. To protect themselves banks charge a foreclosure fee.
Moreover, some banks do not even allow foreclosure of loans or have certain restrictions. Like they might not allow foreclosure for the first 6 months or 1 year of the loan period.
If your monthly income increases in the future, then you can pay off your loan earlier and save some interest without paying high foreclosure charges.
7. Do not go more than 2-3 lenders
In Rule 4, we say that you must shop for low personal loan interest. But in order to do that, you must not go to more than 2-3 lenders. Approaching more than 3 lenders can be counterproductive.
As each time you approach a bank or a lender, they pull your credit score from the credit bureau. And with each time your credit score gets pulled, your credit score takes a dive.
And as your credit score takes a dive, chances are Banks will reject your loan. As they can see from your credit report that you are in dire need of some money. They can smell your desperation.
Pro-Tip – Never ever got to a lender just to enquire about interest rates and then give your PAN card and other details. Rather search online for best rates.
And when you find one with low-interest rates only then approach a lender.
See, living beyond your means is like a time bomb. It is destined to blow. You should plan your expenses according to income and not the other way around.
Personal loans can be a useful tool in your time of need. But do not let them take a toll on your finances in the long run.
If you follow these rules wisely, then you will be able to use personal loans to your advantage. If not then you will dig a grave for your finances by yourself.