When NOT to take a personal loan

Whenever people have a requirement for some urgent cash and cannot come up with the amount needed with the resources they have, they inadvertently apply for a loan from a bank.

Getting a loan today has become very easy, what with the stiff competition prevalent among different banks. The easiest to get among the plethora of loans available are personal loans.

Personal loans are easy to get, but they have their pros and cons:

Pros

• No collateral: Unlike other types of loans, you don't need to produce any collateral, or security, to avail of a personal loan.
• Can be taken for any reason: Normally a personal loan is just that -- for personal use. Once you satisfy the loan eligibility, the banks give you the loan, irrespective of how you put the money to use.
• Minimal paperwork: Banks normally do not ask you for more than a few critical documents for approving a loan.

Cons

• Strict qualifying criteria: Because of minimal paperwork and no security, qualifying for a personal loan is a strict affair.
• High interest rates: The interest rates for personal loans are very high and second only to the extremely high interest rates charged by credit card companies for credit card cash advances.
• Lots of fine print: The loan agreement has a lot of clauses in fine print, which one needs to understand thoroughly before opting for a loan.

When is it okay to take a personal loan?

• Paying off your credit card dues: Personal loans make sense when you have to pay off huge outstanding amounts on your credit cards. The interest rates charged by credit cards are very high, sometimes amounting to 45 per cent per annum. Therefore, taking a personal loan to pay off the credit card turns out to be a good option to reduce the amount of interest you pay.
• An urgent requirement for cash: Because of minimal paperwork, getting a personal loan is a fast process. So if you are really in a tight spot and need some urgent cash to bail you out, personal loans make sense.

It is important to understand that personal loans are a good option only if the amount you require is not very big and your monthly budget can easily fit in the added EMI expense. Exercise the option of taking a personal loan, only because you have no other option and it is possible to pay it off in as less a time frame as possible to help you save on the interest cost.

When is it not okay to take a personal loan?

• Financing the home improvement: In case if you are looking for doing some repairs to your house, opting for a personal loan is not necessary. You can do these repairs with a home improvement loan.
• Buying a car: If you are buying car, a car loan would take care of your needs. You do not need to take a personal loan for that.
• Speculative purposes: Never take a loan to invest in stock markets or other speculative purposes. This is nothing short of a gamble where you might lose out the money invested. Short-term speculative investments are not a wise option to use your money for, especially in the instance of having to opt for a personal loan.

Alternatives to a personal loan

Loan against property (LAP) is a good option that can provide you loan at lower interest rates to the tune of 3-4 per cent lesser. The loan is available at a certain percentage of the property's market value, usually around 40-60 per cent. LAP interest rates are cheaper by 3-4 per cent compared to personal loan rates.

You could also utilise any investments you might have made so far, like shares, securities, fixed deposits, gold, insurance policies, etc. You can pledge these as collateral and obtain a loan against them.

For instance, you can obtain a loan against the surrender value of your life insurance policy from the insurance company or from a bank or obtain a loan from your provident fund account if you have had an employee provident fund account for more than five years.

The interest rates would definitely be lower compared to the personal loan interest rates.

So before you decide to go in for a personal loan, check alternatives with lower interest rates. A personal loan may be easy to get, but does not necessarily become the best solution.

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