It is not uncommon to see people taking personal loans. It is also not uncommon to see banks & NBFCs pushing for personal loan. For the users, personal loans provide immediate cash to fulfill their requirements – e.g. funding a wedding, vacation, house construction or repairs, buying furniture, unforeseen medical emergency and so on. For banks, it provide a great way to increase profits, since the interest rate is usually higher, given the relative insecure nature of personal loans.
If you are a regular user of personal loan, then all may not be well. Personal loans come with its own set of problems, and are something one should ideally be staying away from it. Bankers may however disagree, and may sell you the idea of fulfilling your dreams using a personal loan and so on. But then, they make money out of it!
Here are few reasons why you should be avoiding personal loans.
Personal loans carry high interest rate
The rate of interest in personal loans is usually higher than other common type of loans like home loans or car loans. Currently most of the personal loans will carry upwards of 10% interest rate. This interest rate increases with a customer’s risk profile & credit rating (e.g. CIBIlL Score). And someone telling you – “Sir, take personal loan at 11% & keep your savings in equity markets which will give > 15% assured returns” is either lying or overselling, or both.
Hidden costs like processing fees
Most personal loans have a associated processing fees. Given the nature of personal loan, wherein loan amount is not huge, this may be a decent chunk of the loan amount, maybe 1-2% of the loan amount. This is often not factored while calculating rate of interest & expected outflow.
Over-stretching your financial limits
Personal loans usually have a shorter duration for repayment, usually to the tune of 2-3 years and this can put severe pressure on your monthly cash outflows for the repayment period. And the fact that you have taken a personal loan is probably an indication of you unable to manage your regular expenses within your source(s) of income and hence this puts an additional pressure. Paying the loan off and getting rid of it may require some serious financial discipline.
Lack of long term financial planning
Having taken a personal loan indicates that you probably don’t have much savings & investments and will be able to invest only once the loan has been reaped. This sets you back by few years in your investment journey. You also lose out on the power of compounding & make compounding work against you. (but in favor of the bank or financial institution which gave you loan). In long run, you may be risking not just your financial Independence but even basic savings.
Symptomatic of bigger issue
You having taken a personal loan is, in all likelihood, symptomatic of a larger issue – that you are unable to manage your finances, don’t have much buffer amount and investments which can be encashed if need be. The question you need to answer is – what led you to this? Whether it is low income, high expenses, luxurious lifestyle, splurging on dining out too often, splurging too much on fashion & luxury – there can be many factors. Unless the root cause is address, things may keep repeating themselves and you may be unable to get out of the personal loan cycle.
So, if you are considering taking a personal loan in future, rethink on why you need to take personal loan. And what were the circumstances that led you to that?
In some cases, these circumstances may be beyond your control. In most, it may be because of something that you didn’t do correctly. And if not addressed, before soon, you may find yourself in this unending cycle of personal loans.
You may also want to read – The story behind credit card debts & personal loans.