Rajesh from Trichy thought he had his finances in control. His government job paid him ₹60,000 monthly. As savings, he had a sizeable emergency fund, and life was going smoothly.
Just when he thought everything was ok, his wife's medical tests revealed she needed an emergency surgery that would cost ₹1.5 lakhs. His emergency fund of ₹50,000 felt insufficient to meet this emergency.
In this scenario, a personal loan from a reputable financial institution is a useful borrowing solution for Rajesh. Getting one is simple, but he needs to remember how to use it wisely. He needs to exercise caution when taking a personal loan.
In this article, we discuss what personal loans are and how they are different from other forms of financing. We also discuss smart ways to use personal loans and help you identify when and when not to use them and how to pay them back without stress.
What is a personal loan, and when should you take one?
A personal loan is a simple borrowing solution that does not require you to pledge security/collateral. As opposed to a home loan where your property is collateral, personal loans can be taken based on your income and credit history alone. This is why personal loans are offered at relatively higher interest rates and are considered risky for lenders. A personal loan does not have any restrictions on how you use the funds. You may use it for any purpose you need.
Personal loans are helpful for emergency situations when you need quick access to funds. They work for situations where waiting to save money is not practical; like quick educational deadlines, medical emergencies, or urgent home repairs.
Like Rajesh, you should consider personal loans when the benefit of getting access to immediate funds outweighs the cost of borrowing.
Personal loans interest rates and terms
Current personal loan interest rates in India generally start from 11% per annum. Financial institutions usually charge processing fees and that usually ranges from 0.5% to 5% of the loan amount. Most personal loan tenures generally range from 12 months (1 year) up to 60 months (5 years). Some lenders also provide flexible tenure options within this range. Be sure to check with your lender on the exact policies and loan terms, since they tend to vary across lenders.
You usually cannot change the amount mid-way, and missing payments attracts penalties. Some lenders allow prepayment, but they charge extra fees for closing the loan early.
Smart ways and reasons to take a personal loan
As mentioned earlier, personal loans make financial sense when you take them for genuine needs. The key here is to understand the delicate difference between wants and real necessities.
Below is a practical look at some smart ways you can use personal loans:
- Medical emergencies are at the top of the list of smart reasons. If your family member needs immediate surgery or treatment, personal loans can provide quick funding. Medical loans can be obtained at even higher loan rates but personal loans are usually available at competitive terms and conditions.
- Educational investments, particularly for skills improvement or higher education for your children should defend the personal loan cost with career opportunities. If the education allows you or your child to obtain something done that leads to an upgrade from a lower job or is tied to earning higher income - the loan becomes worth it. For example, if you take a ₹3 lakh personal loan to pay for the MBA that allows you to increase your salary from ₹30,000 to ₹60,000 per month, that seems reasonable for a ₹3 lakh loan.
- Debt consolidation is another smart idea. For instance, if you are paying 18-24% credit card interest rates for credit card debt or several small loans which exist in your life, obtaining a personal loan at 16% to consolidate makes sense because you can save significant money. Moreover, you would still have one EMI, where you would have had to total out for several, so there is decreased complexity and stress, and amount of total interest paid.
- You may take a personal loan for improving your home. For example, if you install solar panels instead of your monthly electric bill, renovating to find better rental, or deciding to make a patio to increase the sale value of the home. At any cost, avoid taking personal loans for extravagant celebrations that create years of financial strain for just a single day's function.
When is a personal loan less ideal?
Personal loans can quickly turn from helpful tools to financial challenges when people use them for the wrong reasons. Here are a few caution areas:
- It is not recommended to use personal loans for lifestyle expenses like expensive phones, gadgets, or vacations. Why? Because these items lose value quickly, you will find yourself in a debt trap or paying high interest for years. A ₹50,000 loan for a phone at 16% interest costs you ₹60,000 over two years. The phone’s worth drops to ₹20,000, but you’re still stuck repaying.
- It is not safe to take multiple personal loans simultaneously. This creates a dangerous debt spiral. Many people borrow from one lender to pay another, thinking they’re solving problems. Instead, they’re multiplying their troubles.
- It is always best practice to have a sound repayment plan before taking a personal loan. Some people take loans thinking their salary will increase or they’ll get bonuses to cover EMIs. When reality doesn’t match expectations, they struggle with payments, damage their credit scores, and face legal troubles.
- Using personal loans for stock market speculation or high-risk investments is not usually recommended. Because you’re borrowing expensive money to gamble with uncertain returns. Even if investments work out, the loan interest often eats up any profits.
How to choose the right personal loan?
While choosing a personal loan that works for you, make sure you are not looking at it only from the point of view finding the one that offers the lowest interest rate. Of course, that’s important but you also need to factor in the full picture to avoid costly surprises later.
Here’s a step-by-step plan:
1. Start by comparing interest rates from different lenders. Go beyond looking only at the advertised rates. Different financial institutions offer different rates based on your credit score, income, and relationship with them. Maintaining a credit score above 750 improves your chances of securing a personal loan with competitive interest rates If your score is lower, expect to pay more interest.
2. Processing fees can significantly increase your loan cost. Different financial institutions charge different processing fees based on their policies. Look for lenders offering reasonable processing fees or negotiate if you have an already built relationship.
3. Loan tenure directly affects your EMI and total interest payment. Shorter tenures mean higher EMIs but less total interest. Longer tenures reduce EMI pressure but cost more overall. Calculate both scenarios using online EMI calculators before deciding.
Related reading: Before finalising any loan, use online tools to understand your exact costs. Check out "Personal Loan EMI Breakdown: What the Calculator Really Tells You"
Useful personal loan repayment strategies
Knowing your repayment capacity before getting into a loan tenure is very important to avoid getting into financial hardship. You should have a solid repayment plan even before you take the loan.
Here are some useful strategies for repayment:
- Develop a realistic monthly EMI budget by listing all your expenses and seeing how much you can comfortably set aside for loan repayments. A safe rule is to keep your EMIs (including any current loans) to less than 40 per cent of your monthly salary/income.
- Set up automatic payments for EMIs to avoid missing dates. Always pay your personal loan on time, to build up a good payment history, which will reflect well on your credit score. Late payments incur heavy penalties and damage your credit profile for future borrowing needs.
- Be prepared to place some prepayment on the loan when you have a little money to spare. Even if you only prepay a little, this can save you a lot in interest when the interest is compounded monthly. If you are or have received some additional money from work bonuses or festive money, if used as a loan prepayment, this reduces the principal amount and future interest burden. Prepayment or penalty charges for personal loans vary across different lenders. Prior to prepaying the loan, do check with your lender if they charge prepayment penalties.
Related reading: Understanding your loan structure helps in planning better prepayments. Read "Customising Loan Scenarios with an Online Calculator" to explore different repayment scenarios and find the most cost-effective approach for your situation.
Conclusion
When strictly used for purposes such as medical emergencies, a necessary education, debt consolidation or home improvements, personal loans can be a useful financial solution. However, there are some areas where personal loans can put you in a bad spot. The main thing to consider is how much you take; you must only take what you are comfortably able to repay. You also want to make sure to compare lenders and have a repayment plan set up before you take the loan.
If you need cash because of an emergency, or a planned requirement, finding the right lender is crucial. Make sure to explore your options, borrow responsibly, and use personal loans to enhance your financial well-being, not to add to your financial stress.
Shriram Finance provides personal loans starting from 11%* p.a. with flexible tenure options of 12 to 60 months. Get collateral-free personal loans up to ₹10,00,000. For more information on personal loan interest rate and charges, visit our website.
FAQs
1. What are the smart ways to use a personal loan?
Personal loans can be used based on your needs; basically whenever you need quick or urgent access to funds without requiring to pledge collateral. Some of the smart ways to use personal loans maybe for unprecedented medical emergencies, home fixes, wedding expenses, and to consolidate other high-interest loan repayments/debts.
2. How can a personal loan be used for debt consolidation effectively?
Personal loans can be used for debt consolidation as you can combine multiple high-interest debts into a single loan with potentially lower interest rates. Always remember to ensure that the new loan tenure doesn't extend beyond original debt timeline.
3. Is taking a personal loan for investment purposes a smart financial move?
Taking a personal loan for investment purposes is not usually recommended. Personal loans carry interest rates starting at 11% but market returns are usually uncertain. This can create a potential debt trap and is therefore not typically considered a smart financial move.
4. When is using a personal loan for a large purchase, like a wedding or renovation ideal?
You may take a personal loan for large purchases like a wedding or home renovation when you have a steady income to pay your EMIs. You can take it when your wedding expenses are essential and not lavish, and when your home repairs need urgent attention (like leaking roofs, or electrical issues).
5. How can a personal loan help in managing unexpected medical emergencies?
Personal loans are useful for managing unexpected medical emergencies when you need immediate access to funds for advance hospital payments. Or when you have critical treatment that can’t wait for alternative funding solutions.
6. What are the alternatives to using a personal loan for various needs?
As alternatives to personal loans for various needs, you may consider gold loans, set up mutual fund investments through systematic investment plans, or build an emergency fund by saving up gradually over a few months.