Should you take a personal loan when facing cash crunch?

The popularity of personal loans has soared high in recent times. In the age of instant approvals and quick disbursements personal loans have become a fast track solution for financial problems. Medical emergency in the family, child’s higher education, paying off high interest debts, funding a vacation, home improvements—these are just a few situations where small personal loans come in handy and provide quick and easy access to funds.

However, you need to be cautious while taking this loan. The temptation of quick and easy availability is so high that people often get caught in debt traps and face a crisis situation later. In order to stay financially safe be doubly sure whether you really need the loan and handle it properly once you take it.

Lenders who give unsecured personal loans offset their risk by pricing them much higher than the loans that are backed by collaterals. An extremely high rate of interest makes this form of credit quite expensive. Keep in mind the following rules before going for an easy personal loan.

 Consider your finances and borrow only the amount that you can repay

Small personal loans have short repayment tenure so large monthly EMIs can strain your budget. Your monthly outgo towards all your loans should not exceed 50% of your monthly income.  If a large part of your income goes into EMIs then your other critical financial goals like child’s education or saving for retirement will get affected. Banks always want you to borrow large amounts, but you should borrow only the amount that you can easily repay.

Do not borrow to splurge

You may have all the reasons to take a break and go on a long holiday, your wife may ask for a diamond ring on the silver jubilee anniversary , your teenage daughter may want a designer wardrobe, luxury watches and high end bags; but remember you should wait till you save enough for these expenses. If you borrow to pay for these expenses you will keep paying the EMIs long after the thrill and excitement to splurge has faded away. Remember to live within your means and borrow only if you really need the funds. After all, unsecured  personal loan only provides instant access to funds. It is not free money. It has to be repaid along with interest.

Do not borrow to invest

The golden rule for investing is to never borrow money to invest. The interest that you get on safe investments like fixed deposits will not match with the interest you pay on loan. Equity investments that do offer high returns are risky and volatile. If stock market declines you will not only suffer losses but will be tied up with an EMI obligation as well.

Consider other cheaper alternatives

Since unsecured personal loans are expensive it is always better to explore other cheaper alternatives first in case of cash crunch. Taking loan against assets like gold or fixed deposit may turn out to be a much cheaper option.

 

There are some situations where taking a personal loan is a wise decision

 

Repay a high interest loan

 

If you have a high outstanding credit card balance with an exorbitant interest rate of 28% it is prudent to take a small personal loan at 18% to repay it and reduce your interest outgo substantially.

 

Consolidating debts

 

In case handling several loans and credit card repayments is becoming unmanageable, small personal loan can be used to consolidate all your payments. Though it is only a transfer of debt pile and does not reduce your overall debt, still concentrating on a single loan payment is much easier.

 

Medical emergency

 

If you need money instantly in case of an emergency hospitalization you can rely on personal loans. Fast approvals and quick disbursement of the loan amount will help in arranging for funds in a much shorter time. An online comparison of personal loan interest rates can help in identifying the cheapest option available.

 

Defaulting on the loan can have serious consequences. Late payments or missed EMIs impact your credit report and mess up your CIBIL score. It may also hinder your chances of getting loans in future. So be a disciplined borrower and make sure you make your repayments on time.

 

Personal loans are easily available today. It is a good option if you are looking at consolidating your debt or paying off a high interest loan. But for spending on luxury items it is always better to save first, than pay a high interest on it. Being thoughtful about your own decisions and actions will save you from entering a debt trap.

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