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Personal loan for financing your lifestyle? Mind these traps

The allure of easy personal loans for meeting lifestyle expenses might land you in an interest trap; consider the loan costs and also try to keep the EMIs within 35% of your income.

By Dhanam News Desk
New Update
Beware of personal loans

Think before you borrow

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As the head copywriter at a major content agency, 30-year-old Ananya was earning 12 lakhs per annum – a decent salary in a growing town like Pune. She had started her career six years ago, with a salary that was less than half the current sum, and as her career progressed, and her salary increased, she had witnessed her lifestyle needs trend upwards.

Until recently, she used to share a 2bhk apartment with three others and shop for luxury items every six months.  With the rising salary, Ananya was now renting the same apartment on her own, and shopping every other weekend. With her expenses increasing faster than her salary, she began looking for ways to supplement her spending power; and, then she came across a platform offering quick and easy personal loans.

With minimal  KYC requirements, and hassle-free loans worth up to 5 lakhs, given her salary bracket, Ananya took her first personal loan to augment her salary now and then. And that was just the beginning. Lured by the magnetic appeal of easy-to-avail personal loans, Ananya soon fell into the interest trap.

The interest trap

A personal loan is very convenient when you want to make a big purchase, the interest is an aspect you should consider to avoid getting blindsided in due course. Personal loans often come with interest rates that are not the lowest available, especially for borrowers with poor credit scores. Lenders typically assess the risk of lending based on the borrower's credit score and those with lower scores may face significantly higher rates.

This discrepancy means that individuals with poor credit could end up paying thousands of rupees more in interest, over the life of the loan, compared to those with good credit. Interest rates for personal loans can vary widely--typically from 12% to 21%--depending on factors such as eligibility, credit score, and loan tenure.

For individuals considering using personal loans to fund lifestyle needs, such as vacations, home renovations, or major purchases, it is important to weigh the cost of borrowing against the benefits. Additionally, improving your credit score before applying for a loan can lead to more favorable terms.

Keep your EMIs under check

When Ananya found it difficult to pay her equated monthly instalments, due to her high expenses and an unforeseen emergency, she decided to take on another personal loan to pay off the first one – and her lower credit score, due to two skipped EMIs, meant that the next loan came with a higher interest rate.

When opting for a personal loan to fund your lifestyle, you must evaluate your cash flow to ensure that you can regularly meet your monthly EMI payments without overburdening your finances. Try to keep your EMIs below 35% of your take-home income, which, in Ananya’s case, would have been 35,000 rupees.

The loan tenure significantly impacts your repayments – while a longer tenure results in lower EMIs, it increases the total interest paid over the loan’s duration. Find a tenure-interest balance that suits your financial situation.

Look for details 

For Ananya, the offer of a 5 lakh personal loan had seemed like a godsend when she was considering ways to boost her spending power and she hadn't gone into the fine print of the loan offer. Before signing the dotted line, you should check other fees you may be required to pay. For instance, processing fees may apply on the loan and can vary between 0.5% and 2.5% of the loan amount, although they are often capped.

It is also important to check prepayment penalties–typically, these penalties are around 2% of the outstanding loan amount, if you choose to prepay within a specified period. These are all ways in which the platform can charge you on top of the hefty interest already being levied. A detail-oriented approach can also help you identify scam offers, which may try to bamboozle you with unbelievably high loan amounts and low interest rates.

Thomas Jefferson once said, “Never spend your money before you have it,” and the adage has never carried more weight than it does now, in the age of personal loans and Buy Now Pay Later policies. With Ananya’s debt mounting, and newer loans attracting increasingly higher interest rates, she realized this the hard way. Before you go in for a personal loan to fund your lifestyle needs, keep the above in mind.

                                                      (By arrangement with livemint.com)