4 Reasons You should Get Personal Loans Only For Emergencies

Most people will need to take out a loan at some point in their life. These days, you don’t even need to reach out to a lender for loans. The chances are that you’re already being bombarded with pre-approved loan offers from all directions.

Quite often, these pre-approved loans are packaged in attractive concepts of vacation loans, marriage loans, etc. to further appeal to the non-financial part of our brains. But one shouldn’t forget that a loan is a loan. Every rupee borrowed will have to be repaid back and with interest. So financially speaking, it makes sense to keep our borrowing to a minimum and, ideally, lead a loan-free life as much as possible.

That said, life will throw curveballs every now and then, and you’ll need money for unexpected things. If you have no other options left, then you can consider taking the personal loan route. However, you have to be sure that you’re very cautious about it.

Personal Loan emergencies

If we leave aside the credit cards, then the personal loans are one of the most expensive categories of loans you can avail of. The reason is that these are unsecured loans and hence, need to charge higher interest rates to take care of the additional risk of lending without any security to the lender.

If you opt for a personal loan, be ready to pay an interest rate of anywhere between 9% and 20% per annum. How much rate you get will depend on your credit score (history), the capability to repay, income patterns, etc.

Ideally, you should only take out a personal loan for emergencies.

Also, at times, the lenders will be willing to lend you more than what you require. It’s highly recommended that you don’t take them up on their offer. Only borrow what you need. Don’t borrow more just because you’re eligible to do so. Because eventually, it’s you who will foot the loan interest bills and nobody else.

All said and done, when is it acceptable to take personal loans?

So here are four emergency scenarios where it’s completely acceptable to take out a Personal Loan:

  • Your family has a medical emergency that’s not covered by health insurance, and you (or the family) also don’t have an emergency fund buffer to dip into. So you need to take care of the situation. And what good will money do if you can’t have it to provide proper healthcare to your family and near ones? In life, all of us have a few people you can’t say no to. Isn’t it? In such cases, taking a personal loan is perfectly fine and justified.
  • You and your family need to travel urgently for some unexpected family reasons, and the last-minute tickets will cost you a fortune. In such a case, if you don’t have savings to take care of the unexpected expense, you can take a quick personal loan. Practically, you can book your tickets using credit cards too and then clear off the dues using a personal loan.
  • Suppose you have an expensive loan (outstanding loan amount), like credit card dues. How expensive? Credit card debt can cost you over 40% p.a. and you also have to pay additional charges on top of that. In comparison, taking out a personal loan at 14-15% p.a. seems like a brilliant thing to do. So you can opt for a personal loan to clear off your high-interest rate credit card dues. But do note that even though you get rid of credit card dues, you still have to pay the personal loan. It’s just that the personal loan rates are cheaper compared to credit card rates, and hence, taking the personal loan is justified in this case.
  • You have some urgent repair work in your house or ancestral home, for which arranging funds might be difficult for any reason whatsoever. In such cases too, you can take a personal loan if other options (like taking help from family, friends, etc.) aren’t working out for you.

These are just four instances, and there are other scenarios where taking a personal loan can be justified. But I hope you get the drift of when to take a personal loan and when not to.

Speaking of when not to, let’s also see when it doesn’t make sense to take a personal loan (even if you feel like doing so):

  • Purchasing new devices, phones, etc. If you need a loan to buy a particular model of a phone, then you don’t need to buy that model at all. You can buy a cheaper model that costs less and comes in your budget. Don’t buy new gadgets unnecessarily on loan unless your income (business) depends on it heavily.
  • These days there’s a trend to take loans for holidays too. No doubt it seems very tempting, and at times, the offers being shown are indeed attractive. Let’s say you love to travel (like me) and want to visit Canada. Now while doing some online search, you come across beautiful images of snow-capped mountains with a subtle message that you can go there very soon without bothering about the costs using personal loans in Canada. Of course, you’ll start contemplating, and it’ll be hard to resist. But financially speaking, it’s imprudent to take loans and spend on non-critical discretionary things. Better to save some money regularly for such goals.
  • Many people borrow and take loans to spend on marriages. No doubt it’s a one-time event in life and very important. But one shouldn’t go overboard with it and only spend what’s financially justified. There’s no point taking out a massive loan for marriage and then complain about repayments for the next several years of your newly married life, is there?

So is there a general approach to deciding whether to take a personal loan or not?

It’s pretty simple, and you might’ve guessed (or understood) it by now. If you just give a thought to it, you’ll always get your answers about whether you should take a personal loan for something or not.

It simply boils down to Emergency Vs. Needs Vs. Desires. That’s it.

  • If it’s an emergency, take a loan (if you have no other option left)
  • If it’s a need that you really need to address (and if you can’t fund it using anything else), then take a loan. Just limit the amount to the bare minimum possible.
  • If it’s a desire, then you already know the answer. Avoid taking the loan. Simple.

Of course, everybody’s situation is unique. So, a need for someone might be a desire for someone else. Or an emergency for someone may be a routine thing for someone else. So, you need to think for yourself and make a call accordingly.

The idea is pretty simple – Don’t borrow unless absolutely necessary and critical.

But just because you need an X amount doesn’t mean that you should borrow it. Whether you can repay it (service the EMIs) comfortably or not is also the question. Isn’t it?

So only borrow that amount which you can easily service the EMIs for. Not just for today, mind you, but for the full tenure of the loan.

For example, suppose you earn Rs 75,000 per month. Your regular monthly expenses are Rs 50,000 per month.

Now you need to borrow Rs 10 lac for some requirement of yours. The loan is available to you at 15% p.a. You checked the EMIs for various tenure and found them as:

  • Rs 34-35,000 monthly for three years
  • Rs 27-28,000 monthly for four years
  • Rs 23-24,000 monthly for five years

Now, after your monthly expenses (Rs 50,000), you only have a surplus of Rs 25,000 per month (Rs 75,000 – Rs 50,000). So, your EMI affordability is only Rs 25,000 per month.

Your monthly EMI should be lower than that. Therefore, in the above case, you opt for 5-year tenure with EMI of Rs 23-24,000 per month.

Another option would be to reduce the loan amount if you want to explore various tenure with an upper cap of Rs 25,000 monthly EMI.

An alternative aspect to consider is the ‘Other Charges’ of the personal loan. What are those? Things like Processing Fee, Prepayment Fee, etc. At times, these other costs can form a substantial part of the overall cost of the loan. So, don’t just look at the interest rate at the time of taking a personal loan. Always consider all the expenses that you’ll have to bear today and later to arrive at your decision to choose a personal loan from many available today. Also, make sure to do your online research to figure out what rates are available across various lenders in the market today.

Another important thing to note is that the better your credit score is, the lower your loan interest rate can be. Yes, banks and other financial institutions consider your credit score while sanctioning personal and all other loans.

If you have a low credit score, then your loan application can be rejected. Or they may approve your application but increase the interest rate.

On the other hand, for a good score, the rate offered will be lower than those given to poor-credit score borrowers.

So, if you have time (and emergency isn’t very time-critical), then you can even check your CIBIL score before applying for a personal loan. That way, you’ll have sufficient information beforehand to be able to negotiate better rates with your lenders.

But what to do if you already have some financial assets that you can sell to avoid taking out a personal loan?

Mathematically, if your investments are earning fewer returns (%) than the loan rate available to you, it does make sense to sell those investments and not borrow.

But it’s not as simple as that as many times, you may have earmarked the savings for some other purpose (financial goal) in the near future. Or at times, fund requirement may be of much smaller amount than the asset in question. So you may not want to sell an asset of Rs 5,00,000 when your requirement is just Rs 1,00,000. Isn’t it? Also, many times, when you try to sell an investment, it may result in large tax outgo due to taxation of capital gains. And the tax outgo can be heavy at times. So, you need to be deliberate and think very carefully about selling an asset before you make the decision whether to take a loan or sell the asset in question.

The ease of taking multiple personal loans (or any other loans) and converting them into small monthly EMIs is also driving the consumption of retail debt like personal loans.

So, what should you do?

The rules of borrowing are still the same, and it’s pretty basic.

You don’t borrow unless you really need it.

Plain and simple.

Ideally, only emergency situations are the ones where you’re justified in borrowing.

No doubt, easier availability of credit is useful for those in need. But its best to avoid taking unnecessary loans or use credit cards you don’t need.

I know being young, you may want to take a foreign vacation as there’s a pre-approved personal loan offer available at a click-of-a-button. I love to travel, and I know it can be very exciting. But borrowing unnecessarily for non-critical discretionary expenses isn’t the best use of your money. You should always deal with such expenses in a planned manner and save for them using goal-based investing.

Also Read: credit cards vs personal loans.

Just remember that not only personal loans but rather all loans should be taken cautiously.

It’s borrowed money. You have to repay it eventually. The longer it takes for you to repay, the more interest you’ll have to pay for every Rupee borrowed. So don’t borrow unnecessarily.

Just make sure that you whenever you want to take a personal loan for something, do assess objectively whether it’s for a real emergency or you’re just being a little carefree in borrowing habits. You’ll get your answer about whether to borrow or not every quickly.

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