Loans can be used for several purposes, which include buying a house or a car, consumer appliances, marriage related expenses, refurbishing a house, education, health issues, amongst others.
This leads to a follow-up question – should we care about why we want to take a loan as long as it is paid back? The answer is a resounding“yes” because a loan should primarily be used for productive purposes.
For example, taking out a loan for a car or house makes sense as it adds to your assets. However, taking out a loan for a vacation or for luxuries can put an extra burden on your finances. Some even use loans for recurring expenditures, such as paying household bills, credit card bills and in many cases paying income tax dues.
You should always look to ascertain if a loan is absolutely necessary. Consider this as your starting point. It is advisable not to pay interest for long tenures unless it is necessary. Before starting the process, it is important to be aware of the pitfalls as taking out a new loan involves a lot of risks.
Unsecured personal loans are the simplest product out there, but the finance industry still manages to squeeze in a good number of extra ways to make money from you.
Below are the ten costliest traps to watch out for when taking out an unsecured personal loan.
Small and fleeting
The temptation with loans, particularly if they are being actively sold to you, is to go for an even bigger sum than you first thought. What’s worse is that the lender will often convince you to drag out the loan for a longer period to reduce your monthly repayments.
It may appear like you are being offered fair advice but the reality is that the lender is trying to earn more money over a longer time frame. When you pay a debt interest, you’ll never get it back, so make sure to keep the loan as short and small as possible to keep down those costs.
Most personal loans have fixed interest rates, but you have to watch out for the occasional variable rate loan. Look for the word ‘fixed’ in the documents and fix it.
Compare The TARNot The APR
The annual percentage rate or APR (for example-‘16% APR’) is meant to be a standard way of comparing the cost of a loan over a year. However, the APR can be manipulated by the lender, so a good rule of thumb to compare the cost of a loan is to look at the total amount repayable (TAR).
This is the total cost including interest and charges that you will pay from your first payment to the last. This will make it easier for you to ascertain whether or not you can afford the monthly payment.
It’s Not All About The Cost
Look for better terms and conditions. With personal loans, this normally means that you’re not charged if you want to pay off the whole loan early. These generous terms are rare, but they do exist, so keep an eye out for them. Ensure that you understand any fine print before you take the loan.
It’s the total cost or the TAR which is the most important figure. However, you also want to know if it includes charges other than interest, such as an origination fee. When comparing loans, make sure you include the origination fees charged by all choices you are considering.
You should compare an unsecured loan with your most likely alternatives. The first and best, if possible, is to save to buy later, but otherwise you can use credit cards to get a short term low interest rate. If you have good credit scores, you can also get lower rates by going to peer-to-peer lending sites.
If you use a personal loan to pay off other debts, ensure you cut up any existing credit cards and close the accounts. Avoid the temptation of using your debt-free credit cards and rack up more debts on them. You will regret it later on.
Overall, be cautious of 0% or low introductory rate credit card offers as they are full of traps.
Don’t Trust Your Bank
Do you trust your bank to have your best interests at heart? Thought not, but that doesn’t stop some people from being persuaded to take out a loan from their own bank.
Your own bank will almost never offer you a competitively cheaper loan, simply because it finds it easy to sell expensive products to its existing current-account customers.
Instead, you should shop around. Visit comparison sites to compare the latest published rates before you apply. Ring up alternative finance companies that you already have good relationships with to see if they’ll offer you any special deals. This has been known to work surprisingly well.
Understand Other Add-On Terms
Some loans come with specific terms in case you miss or default on the loan. Costs associated with PPI(Payment Protection Insurance), collection fees and late payment penalties must be understood clearly before you take out a loan.
Loans should be simple products, but lenders like to entice you with things such as cashback and payment holidays. Loans with cash back are inevitably more expensive, particularly if you want to pay off the loan early, as you will lose the cash back.
Payment holidays (which are when you can take a month or two off payments) are really sneaky as the interest will still build up in that time, and it will increase your repayments for the rest of your loan. Such a break can be surprisingly expensive.
Who Can Avail Loans?
Technically anyone with a good source of income, either through a salaried job or through a business, qualifies for a loan. However, if the bank feels your income would not be able to service the loan, there is every chance the bank will refuse the loan or offer a reduced amount in funding. For people borrowing for the first time and with little credit history, a bank relies on the source and adequacy of your income and your ability to pay back.
On the other hand one does not need a stellar credit history to borrow from a bank. Someone with a less than impressive credit history is also likely to raise a loan, although in most cases at a higher interest rate.
If you have managed to save diligently, banks will certainly be interesting in hearing from you.
What To Do If You Are Refused A Loan By Your Bank?
If you get refused a loan or you feel that the interest rate being charged by banks is too high, it may be worthwhile to get your credit scores. Banks often rely on the credit reports to come at a decision and every bank has their own discreet criteria and scoring systems to come to a decision.
This report contains information about your previous loans (if any), your repayment history, income, occupation among a host of other information. By knowing what is in your file, a lot of things regarding the borrowing process from a bank becomes clear. These reports can also work in your favour sometimes. For example, if you have a great credit history, you can use it as a bargaining tool.
What to Do If There Is an Error in Credit Report?
While financial information by several credit rating agencies are collected from numerous sources and are generally accurate, there are still chances some error may occur. In such a scenario, you can make a representation to the credit agency with the necessary documents to remove the error.
This process can be done online as well. Keep in mind that all financial institutions take about a month to communicate credit details of an individual with the credit rating agency. Given the time lag, there is a strong possibility you may get an error in your credit report because all details may not have been updated.
In cases where you find your credit rating is poor, ensure you clear your outstanding dues, refrain from any late payments, reduce the amount of unsecured loans (such as personal loan, credit cards etc.) and apply for new credit in moderation.
Keep the above mentioned points in mind and avoid the pitfalls while going for a loan and you will be able to make the right use of it.