Personal loan is one of the most preferred loan options for financing planned expenses and/or dealing with financial shortages or exigencies. However, lack of awareness about personal loans and/or negligence while applying for the loan might lead to the applicant making some mistakes, which can either lead to the rejection of your loan application or the selection of sub-optimal loans.
Here are the five common mistakes that prospective applicants should avoid while applying for personal loans.
Exceeding the EMI/NMI ratio
Lenders usually use the EMI/NMI ratio to evaluate their loan applicants’ repayment capacity. The EMI/NMI ratio is used to calculate the total share of an individual’s net monthly income (NMI) that goes into paying off his/her existing debt obligations as well as the EMI of the proposed personal loan. Banks and non-banking financial companies (NBFCs) usually grant personal loan approval to applicants whose debt obligations, including the EMI of the proposed personal loan, are confined to 50-55% of their net monthly income. Those surpassing this limit are less likely to get approval on their personal loan applications. Therefore, prospective applicants should use personal loan EMI calculators to determine the optimum tenure, which keeps their EMI/NMI ratio below the above-mentioned limit. Applicants exceeding the 50-55% limit can select longer tenures for their personal loans to reduce their monthly EMI payouts. However, note that opting for longer tenures will increase their interest cost burden.
Not exploring other personal loan offers
The interest rates on personal loans may vary widely across multiple lenders due to their credit assessment processes and the underlying risk factors. Hence, prospective borrowers should compare personal loan schemes of multiple lenders before applying for a loan. They should first approach their existing lender(s) with whom they have deposit, lending and/or credit card relationships. The personal loan offers from these banks/NBFCs can be used as a benchmark to compare with the personal loan schemes offered by other lenders. Several lenders also offer interest rate concessions on personal loans to their existing customers. Many lenders also offer pre-approved personal loans to their select existing customers having strong credit profiles, with instant/same-day loan disbursal and minimal documentation. Prospective applicants can then visit online financial marketplaces to compare the personal loan rates of interest and other features offered by other banks/NBFCs, on the basis of their credit profile, before making the final loan application.
Applying for personal loans with multiple lenders within short durations
When a lender receives a personal loan application, it fetches the credit report of the applicant from the credit bureaus to determine his/her creditworthiness. Credit bureaus consider such lender-initiated requests for credit reports as hard inquiries. The bureaus subtract a few points from the loan applicant’s credit score for every such hard inquiry. Therefore, multiple hard inquiries within a short time span may lead to a significant dip in the applicant’s credit score, which in turn reduces his/her chances of availing personal loans or other credit options in the future. To avoid this, loan applicants should visit online financial marketplaces in order to compare the personal loan schemes offered by multiple lenders before choosing the most suitable offer. Credit bureaus consider any credit report requests raised through online marketplaces as soft inquiries, which do not affect your credit score.
Ignoring part-prepayment or foreclosure charges and related terms
Lenders can levy penalties of up to 5% of the outstanding loan amount from borrowers prepaying or foreclosing their personal loans. Note that RBI has barred banks from levying part-prepayment or foreclosure charges on personal loans with floating interest rates. However, no such restrictions are applicable on fixed interest rate personal loans. Some lenders also restrict their personal loan borrowers from part-prepaying/foreclosing their loans before they pay a predetermined number of EMIs. Hence, borrowers should compare the part-prepayment or foreclosure charges and related terms of multiple banks/NBFCs while comparing their personal loan offers.
Not considering alternatives to personal loan
Secured loan products like gold loans, loan against property, loan against securities and top-up home loans have no end-usage restriction and therefore, can be considered as alternatives to personal loans. Additionally, lenders usually set lower interest rates for secured loans compared to the interest rates offered on personal loans. For example, existing home loan customers can avail the home loan top-up facility, whose interest rates are usually the same as or marginally higher than their underlying home loans. This makes top-up home loans a more cost-effective alternative than personal loans for existing home loan borrowers.