Applying for a Personal Loan? Avoid These 5 Mistakes

Personal loan is a go-to option for meeting your immediate financial requirements. You can easily avail the loan without providing collateral or specifying a purpose. The adoption of digital processing has further increased its merits by enabling hassle-free end-to-end online processes that require minimal to no documentation and ensure faster disbursals. While availing personal loans have never been this easier, lack of awareness and carelessness can lead applicants to making simple mistakes while applying for the loan, resulting in loan rejection or sub-optimal loan selection.

Here are a few mistakes prospective borrowers should avoid when applying for a personal loan.

Exceeding your EMI/NMI ratio

Banks and NBFCs use EMI/NMI ratio to assess their personal loan applicant’s loan repayment capacity. The ratio expresses how much of an applicant’s net monthly income (NMI) goes into paying off his existing debt obligations, including the proposed personal loan EMI. Lenders usually prefer sanctioning personal loans to applicants having debt obligations (including the proposed loan EMI) within 50-55% of their net monthly income. Applicants exceeding this mark have lower probability of getting loan approvals. Therefore, before applying for a personal loan, one should use online personal loan EMI calculators to determine an optimum tenure, which keeps his EMI/NMI ratio below the aforementioned limit. However, keep in mind that a longer term would also mean paying more in interest.

Applying with multiple lenders in a short period of time

When a lender receives a loan application, it collects the applicant’s credit report from the credit bureau. Credit bureaus call these lender-initiated credit report requests as hard inquiries. For each hard enquiry, credit bureaus deduct a few points from the applicant’s credit score. So, having multiple hard inquiries within a short duration may cause your credit score to dip quickly, thereby reducing your chances of availing approval on personal loan or any other credit option in the near future. This is why rather than submitting loan requests directly to lenders, individuals should visit online financial marketplaces to select the best personal loan offer. Credit report enquiries raised through such online market places are regarded as “soft inquiries” and does not affect your credit score.

Not exploring other personal loan offers

The interest rates offered on personal loans can widely vary across lenders due to their varying risk factors and credit assessment processes. Therefore, one should compare personal loan offers from as many lenders as they can. To do so, individuals should first contact banks and NBFCs with whom they are maintaining deposit, loan or credit card accounts. This is because many lenders provide pre-approved offers to their existing customers with strong credit profiles. Such pre-approved offerings feature quick or same-day disbursals and require no or very little documentation. Many lenders also offer lower interest rates to their existing customers. For example, HDFC Bank customers can approach their bank to enquire about their prevailing HDFC Personal Loan Interest Rates and if they are eligible for any concessions on those rates. Furthermore, the interest rates and features offered by your current bank(s) can be used as benchmark to compare offers from other banks and NBFCs.

When shopping for personal loan offers, one should visit online financial marketplaces to compare personal loan interest rates from multiple lenders based on your credit profile. Besides interest rates, applicants should also check for loan amount, tenure, processing fees, prepayment/foreclosure charges, disbursal time and other loan terms before making the final loan selection.

Ignoring prepayment/foreclosure charges and related terms

On prepaying or foreclosing a personal loan, your lenders can levy a penalty of up to 5% of the outstanding loan amount. While the RBI bars lenders from charging prepayment/foreclosure fees on floating rate personal loans, no such constraints are applicable to fixed rate personal loans. Many banks and NBFCs also limit their fixed rate personal loan borrowers from foreclosing/prepaying their personal loans until a certain number of EMIs are paid. Hence, prospective borrowers, especially those wanting to keep their prepayment/foreclosure options open, should also look into prepayment/foreclosure charges and related terms when shopping for personal loan offers.

Not factoring in personal loan alternatives

Like personal loan, secured loan options such as loan against securities, gold loan, top-up home loan and loan against property have no end-use restriction and hence, can be an alternative to personal loans. Moreover, due to their secured nature, lenders offer such loans at much lower interest rates than personal loans. For example, home loan borrowers can avail top-up loan facility whose rate of interest is usually the same as that of its underlying home loan or a bit higher, making it a more cost-effective alternative to personal loans. Moreover, based on the residual tenure of the underlying home loan, the tenures on top up home loan can extend up to 15 years. Hence, borrowers with longer residual tenure on their home loans will be able to avail longer tenures on their top up home loans, thereby, increasing their EMI affordability.

Individuals owning sufficient gold jewellery may want to consider applying for gold loan as an alternative to personal loan. Similar to personal loans, gold loans are usually disbursed in a few hours of making the loan request. However, the interest rates on gold loans are usually lower than personal loan interest rates, especially for applicants having lower credit scores.