Ah, the personal loan: Prelude to successful investing, or dialling suicide prevention. Amongst all the financial options you can choose, this one is the deadliest. Use personal loans right, and they could be the ladder out of your financial ditch. Use them wrong, and it’s like trying to put out a house fire with gasoline. In this article, we’ll look at the main considerations before taking a personal loan:
Personal Loans vs. Other Loans
Personal loans are unsecured, high-interest loans. That makes them almost like credit cards. However, the loan tenure can span a few years: Three to five year loans (for education, renovation, etc.) are not uncommon.
Interest rates for personal loans vary widely. Depending on the loan’s tenure and quantum, the interest can range from 5.88% to over 9.5% per annum.
Personal loans are unspecific. Unlike car loans, education loans, etc., the bank just lends you money, without checking what you want it for. You just buy whatever you need.
Or frighteningly, don’t need. Personal loans are not for impulsive spenders. Be sure to check out what you are getting yourself into with sites like MoneySmart and their Personal Loans Wizard before going any further.
Before you get a personal loan, ask yourself the following:
- Would Another Type of Loan Cost Less?
- Am I Investing the Money?
- Will I Be Over-Leveraged for Other Loans?
- Do Other Banks Offer Better Rates / Benefits?
- Do Retailers Have Better Options?
1. Would Another Type of Loan Cost Less?
There’s a reason why we have car loans, renovation loans, and other “insert purpose here” loans.
Yes, you could get a personal loan to pay for any of those things. But specific loans tend to have lower interest rates, and carry more benefits. For example, if you already have a home loan from a bank, you can sometimes get interest free renovation loans as well. Such a renovation loan would be much cheaper than a personal loan.
If you’re self-employed, avoid using a personal loan as a de-facto business loan.
I know business loans are a pain to apply for; the credit officer asks more questions than homeland security at a dynamite store. But once approved, business loans tend to have lower interest rates compared to a personal loan.
No one can stop you taking a personal loan, and then pumping the money into your business. But before you do that, at least try to discuss business loans with the bank.
2. Am I Investing the Money?
Are you taking a personal loan to buy stocks, gold, or make some sort of investment? Yes?
Then I encourage you try safer activities. Like chainsaw juggling or naked bear wrestling, both of which are significantly less dangerous.
Understand that you can never raise capital by taking personal loans. You’re really just leveraging your financial future. Also, few investments appreciate faster than a personal loan’s interest rate (around 6% per annum). Even if you don’t go broke, you will probably incur a loss.
3. Will I Be Over-Leveraged for Other Loans?
Avoid taking a personal loan within three months of other loan applications. Take, for example, a home loan.
Let’s say you’re intending to buy a house next month, and haven’t gotten a home loan yet. You also need 20% down-payment for the house, which can’t be covered by the home loan. So you apply for a personal loan, to cover the 20%, and it’s approved.
After the personal loan is approved, you apply for the home loan.
The bank then checks your DSR (debt servicing ratio). DSR measures your income against your overheads: If your DSR exceeds 50%, most banks won’t approve your home loan.
Speaking of which, you know what add to overheads? Stuff like personal loans. Your personal loan will worsen your DSR. And when it does, you can’t borrow as much as you’d like.
4. Do Other Banks Offer Better Rates / Benefits?
As I mentioned, different banks offer different interest rates and benefits. Examples are “interest free” months, or lower interest for existing customers.
To find out which bank has the best offer for you, call them and compare their offers. You can also use loan comparison sites like MoneySmart.
5. Do Retailers Have Better Options?
The following is from Interior Designer Hedy Chua:
“Many furniture stores can give you interest-free hire-purchase. Especially if you have a contractor or a designer, many of us (designers and contractors) have contacts for sourcing furniture, fittings, and so on.
I believe if you can get such interest-free hire-purchase deals, and you can top up some cash, you may not even need a renovation loan.”
Likewise, if you’re buying something expensive (e.g. piano), see if the retailer has an installment plan. This might turn out to be cheaper than the bank’s personal loan.
You can also follow us on Facebook; we’ll let you know when we spot good deals. Otherwise, make sure you compare the best personal loan packages first and see what promotional interest rates are available instead of just signing up for the most convenient one.
Got a question about personal loans? Ask MoneySmart, and we’ll answer. Or comment and tell us your personal loans experience.
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Tags: Personal Loans