Personal loans are expensive but sometimes they are the best option to choose. Personal loans can be used for any purpose because the nature of loan is for personal purposes. There are some lenders who ask what are your plans to do with the loan amount. The reason is that they just want to make sure the loan is paid back on time. Personal loans are good and sometimes otherwise as it all depends on how you spend your money. Here in this article we will define how personal loans are a good idea and you can make the right decisions on taking the loan.
What is a personal loan?
An unsecured loan where the lender does not ask for any collateral to lend money is called a personal loan. The lender takes a higher risk and thereby charges a higher interest compared to a secured loan. The loan amount that the lender provides you depends on the various factors including your credit score and debt to income ratio.
There are some banks which provide you with secured loans and the collateral may be your car or property. A secured loan has lesser interest compared to unsecured loans. If you are unable to pay off the loan then you will lose your collateral. Payment history is the most important factor which will account for 35 percent of your credit score.
When should you take a personal loan?
You can consider choosing personal loans when you do not have any collateral to offer for a loan. The credit card limit is not sufficient for your needs. You can opt for a personal loan when you are not qualified for a low interest credit card. When you want to borrow money for a certain period of time say between one year to five years. Below are a few most common situations when you choose personal loans.
- Consolidate Credit Card payment
- Payoff high interest rates debts
- Big ticket purchases
- Payment towards life big events
- Credit score improvement
- Consolidate Credit Card payment
When you are due for a payment on more than one high interest payment on credit cards then taking a personal loan and paying off the outstanding balance is a good option. This will save a lot of money. The average interest rate on the credit card is 23.99% whereas the average interest rate on a personal loan is 11.48 percent.
The difference between the interest rates is very high and by taking a personal loan you can pay back the dues on the credit card and avoid paying higher interests. Sometimes personal loans is not the only option left for you, instead you can transfer your balances to a new credit card with low interest rates. Some lenders provide offers on waiving the interest rate as a promotion offer for a period of 6 months.
Click here for Top 10 personal loans in UAE
- Payoff high interest rates debts
Personal loans are more expensive than any other types of loans but there are other types of loans which carry more interest than personal loans. Suppose if you have a payday loan then the interest rates are higher than the personal loans. If you have any old loans with high interest rates then you can choose personal loans to replace the old loan with a new loan.
Taking a personal loan to repay payday loans and old loans is a good option but it is also important to check the prepayment penalties or any other charges. Calculating the prepayment charges and other penalties is important to save your money.
- Big ticket purchases
Taking a personal loan for big ticket purchases is a good option especially when you are buying major purchases of your life. This can be buying a home or appliances or making renovations to a home. Taking a personal loan can be cheaper than financing through money lenders or spending through credit cards as these have higher interest rates. Big ticket purchases are a great way to feel the sense of accomplishment and achievement but they come at a cost.
- Payment towards life big events
Life big events like marriage, world tour or buying a villa or any milestone purchases is a one time achievement. The payments towards these expenses is very high and in these situations opting for a personal loan is a good option. You can avail the loan and carry forward the payments into monthly installments for a longer period of time so that you do not feel the pinch in your monthly salary.
These events are important but how much it is worth depends on the earning capacity of the individual. A lower earning capacity borrower taking a huge loan for a world tour and facing a pinch in salary every month is not a good option but again it depends on the individual choice because some may consider it as a lifetime event.
- Credit Score Improvement
If you do not have a credit score or if you have a lower credit score then taking a personal loan and paying it off in a timely manner will help to improve your credit score. If you have a bad loan payment history with missed payments then taking a personal loan and repaying the loan will help to improve your credit score. If you have different types of loans and if you show that you can pay off them clearly, it is a good sign for improving your credit score.
It’s important to note that just for improving your credit score you need not take a loan, you can also improve your credit score by low credit utilization, not opting for new credit cards, not applying for multiple loans and keep paying your dues on time then over a period of time you can improve your credit score.
Click here for Credit card utilisation – Impact on credit score
When you should not take personal loans?
When your income level is beyond the loan repayment capacity then you should not consider a personal loan. Do not use personal loans for day to day living expenses, When you are already in a default and again choosing a personal loan for repaying debts is not advisable.
Do not choose the loan of lowest rate of interest without considering other factors. When you do not have a stable job do not take personal loans. Do not take personal loans and give to friends or family members as loan repayment risk will be on you. Avoid yourself falling into a debt trap.
Why should you take personal loans?
The most common reason for opting a personal loan is debt consolidation, home improvements and big ticket purchases. It is noted from a survey that most people use personal loans for marriages, emergency expenses, home renovations and paying back high interest rates debts. Since these expenses are important and there is no collateral requirement, getting a personal loan is a good option.
Take away
Personal loans can be used for any reason as these are unsecured loans. Personal loans are easy to avail and have less interest rates than credit cards. When you should take a personal loan depends on your requirements but it is more important that how you are utilizing your personal loan. If you misuse the loan amount then you will start building the risk of debt payment. If you utilize the loan amount in the right way then you avoid yourself falling into debt trap.
About the author
Vinay Kumar Goguru is a finance professional with more than 8 years of diverse experience as a researcher, instructor and Industry work experience with both public and private entities. Prior to MyMoneySouq, he spent 6 years in Berkadia, It's a commercial mortgage banking company. He has a "Doctoral Degree in Commerce" and two master's degrees with a specialization in Finance, one as Master of Commerce and other as Master of Business Administration. He has written several articles on personal finance, published by different International journals. He loves traveling, reading and writing is his passion. He has a dream of writing a book on his favorite finance topics.
