Personal Loans – How to borrow if you Can’t Avoid?

Personal Loans

A friend recently needed some money to spend (or maybe splurge) on his wedding. 🙂

I helped him a bit. But since his need was greater than what I could pitch in with, he went ahead and took a small personal loan too.

I know what you are thinking.

Taking a personal loan to spend on discretionary expenses like a wedding, holiday, etc. is financially incorrect.

I agree. It doesn’t make sense.

But let’s be a little realistic here.

It’s easy for us to write here that one shouldn’t take a personal loan and this and that. But given the fact that our society ‘still’ gives importance to a lot of things and since we need to move around in the same society, many people end up taking loans to fund such discretionary expenses.

Please don’t think that I am in favor of such behavior. I am not judging anybody here. I am just telling what I observe. It’s not uncommon to see parents dipping into their retirement savings to fund their children’s big fat wedding and as a result, screw up their retirements. Look around and you will find such people. 🙂

I respect them for the sacrifices that they make, knowingly or unknowingly.

I have nothing more to add here on the justification of people taking loans for discretionary expenses. There are solid views on both sides of the table. Most people are borrowing out of compulsion (real or perceived).

We will only waste time by judging them or by being idealistic. 🙂

The fact of the matter is that people have been doing it and will continue to do it.

And by the way, the friend I helped – I can never judge him too 😉 It is difficult to say no to your close ones. Atleast I find it very difficult.

But let’s come back to the point.

Now my friend took a loan for his discretionary expenses. But there are genuine cases where people need to take personal loans for real emergencies.

In such cases, and in absence of a decent enough contingency (emergency) fund kept aside for such purpose, a person is really left with three options:

  1. Ask friends or family for help
  2. Dip into the savings & investments
  3. Take a (personal) loan

One thing about emergencies is that if it eventually boils down to the 3rd option of taking a loan, then the cost of money becomes irrelevant. Oh come on… it is an emergency and you cannot bother about the cost at such moments! You need money no matter what at such times!

If you are unable to arrange funds from elsewhere, the personal loan is a go to option most of the times (credit cards can also come in handy for immediate liquidity needs). The best part is that such loans can be quite quickly, in less than a couple of days depending on the lender-borrower dynamics. And since these are mostly unsecured loans, there is no need for any collaterals or guarantors.

Obviously, these conveniences come at the cost of comparatively higher loan rates. But that is an acceptable tradeoff I guess for the cash you are getting access to on an urgent basis.

But before I move forward, let me say that that you should go for personal loans only if you really need the money and you cannot arrange it from elsewhere.

And I really mean… that you borrow when you ‘really need it!’

As for the definition of ‘real need’, its best left to each and everyone to figure it out.

Most people are smart enough to know it.

Important Things to note when taking a Personal Loan

1) Aim for Lower Personal Loan Interest Rates

This is a no brainer. Lower the rate better it is for you. But you may have to accept higher rates at times if the loan amount you need is available from a lender who is charging slightly higher. Isn’t it?

Generally, the interest rate offered to you will depend on factors like your age, income stability, whether salaried or self-employed, years of work experience, credit score, existing EMIs, your repayment capacity, loan tenure, etc.

Just be careful about the loan rates and try to bring it down to as low as possible. Don’t just stick to your existing bank to check for personal loans. There are several online tools to help you compare personal loan rates across banks and NBFC. Make use of such tools.

2) EMI you can Afford + Tenure as short as Possible

The mathematics of loans is such that the loan tenor you select along with the loan amount and the interest rate determines your final EMI.

EMI should be affordable and comfortable for you to manage during the full tenor and not just initially. So find out what is that you can comfortably manage first. And then manipulate the loan tenure and/or the loan amount to arrive at an EMI that is affordable for you. Go ahead and use personal loan EMI calculators that are easily available online. These personal loan calculators not only show the loan EMI but also tell you the total loan interest payable throughout the loan tenure.

Spend some time on the calculators and play with options. It will give you a clear picture about the loan you can afford and how to go about it.

But here I must highlight one thing. Being comfortable with EMI is one thing. But ideally, you should also try to keep the repayment period as short as possible.

The reason is that it will reduce your total interest burden during the loan tenor. Although your EMIs for a short-tenor loan would be higher than a longer-tenure loan, it makes mathematical sense to reduce your total interest outgo. Here is a small example to help you understand this:

Suppose you avail a personal loan of Rs 5 lakh at an interest rate of 16%. Then your total interest paid over the loan tenor would be as following:

  • 5-year Tenor – Rs 2.29 lakh
  • 4-year Tenor – Rs 1.80 lakh
  • 3-year Tenor – Rs 1.32 lakh

Ofcourse, you need to consider EMI affordability too, which changes with loan tenor:

  • 5-year Tenor – EMI of Rs 12,159
  • 4-year Tenor – EMI of Rs 14,170
  • 3-year Tenor – EMI of Rs 17,579

But I hope you understand what I am saying. If you can increase your EMI a bit, you can easily save a lot of money on interest. I did a similar analysis for home loans. You can read how shorter loan tenor reduces total interest outgo for home loans.

3) Loan Amount

What about loan amount? You already know how much you need. Isn’t it?

In many cases, lenders attract potential borrowers to borrow more than what they actually need but playing around with tenor and EMI. Please don’t do that. Just because you can avail a loan, don’t go overboard. Take a loan amount of as small an amount as possible.

This is the reason why you should be very cautious about going for pre-approved personal loans that are bombarded on you via emails, calls and other means!

If you already have a Personal Loan?

Taking loans is one thing and managing them smartly is another.

Some people are really smart about how they manage their debts. Their proper loan management helps them add real value to their financial portfolio.

Using the previous example of a borrower taking a Rs 5 lakh personal loan, you have seen that how just a few thousand more every month can be a smart money move to reduce the total interest burden over the loan tenor. An additional benefit is that with a shorter loan tenor, you become debt free much quickly.

Then if you are savvy enough, you can try for transfer of your existing loan to reduce your interest rate. It’s possible to get a personal loan balance transfer from existing lender to a new one. It benefits as the new lender may be willing to reduce your interest rate or provide more loan (if you need) or increase the tenor. This can work well for some people in many ways.

At times, you may get additional funds. Now you may think whether it makes sense to repay a part of the loan or not. Another possibility can be to utilize that amount to invest elsewhere. I have addressed this dilemma in detail already. You can read Payoff Loans Vs Start Investing.

Can better planning help?

I understand that we cannot plan or predict everything. And unexpected and unplanned emergencies will come.

But some level of planning can help you be in better control of your financial life.

Having a reasonably sized emergency fund can help at such times. You will not need to take a loan or dip into your savings for other critical financial goals.

Remember, that if you are repaying a loan then that also means that the money available to invest for other future financial goals is reduced. So some bit of planning can go a long way in sorting out your financial life.

Finally…

There is not much to add.

Generally, it is advisable not to take a personal loan for discretionary expenses. It’s best to save for such expenses first and then spend. This requires some planning that can be done in a goal or expense based financial plan.

However, if you really need to take a personal loan due to an emergency, make sure that you do consider interest rates, charges and convenience. It’s easier said than done because it would be difficult to find time for these things during an emergency. But this is what is important. Atleast you should know what to look for when going for personal loans.

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