Personal loans provide quick financial solutions, but they often come bundled with hidden costs that inflate their true expense. Prudent borrowers must recognise these simple traps to avoid unexpected financial complications.
Before going ahead with any particular personal loan product, you should carefully understand the intricacies of the loan product, i.e., terms, interest rates, repayment tenures, and flexibility related to the product, before applying for it.
Let’s break down the five most common traps that make personal loans heavier on the pocket than expected, and how to steer clear of them.
1. Hidden charges escalate loan costs
The processing fees of personal loans are generally between 0.5% and 3% of the total loan amount. This sum is deducted upfront or from the sanctioned amount. Such deductions add to the effective cost of the loan.
Furthermore, late payment fees, prepayment charges, or foreclosure charges, and stamp duty are some other expenses that can escalate the cost of the overall loan. Failure to reasonably account for these hidden charges often results in more expensive borrowing than the headline interest rate suggests.
2. Changing interest rates and affordability pressure
The personal loan interest rates currently range from approximately 10.90% to 24% across various banking institutions. The final interest rate applicable on a case-by-case basis depends on credit profiles; even minor rate hikes can push EMIs higher. This often forces borrowers to think about extending tenures, ultimately increasing the total interest outgo and bringing down the loan affordability.
3. Multiple loans can trap borrowers in debt
Taking several personal loans simultaneously or borrowing beyond repayment ability can have serious consequences. It can result in borrowers falling into a debt trap. Compounding of interest in such cases and the missed payments can cumulatively degrade the credit scores and financial prosperity, and can make borrowing an unpleasant experience.
4. Long loan tenures increase interest burden
To deal with immediate challenges due to the pending EMIs and their size, borrowers sometimes can even opt for longer repayment periods. This is specifically done to reduce monthly EMIs. Still, such a step can result in higher cumulative interest payments.
Hence, a shorter tenure means higher EMIs, and it also substantially lowers the overall interest rates. The final choice in this regard must be made after careful consideration of both scenarios and guidance from a qualified financial advisor.
5. Ignoring repayment strategies means more costs
Several borrowers miss out on effective repayment strategies and optimisation tactics due ot improper planning. Strategies such as making part-payments, refinancing loans at lower rates, or prioritising high-interest debt increase the cost of loans unnecessarily.
As a sensible borrower, you should plan loans properly and opt for effective repayment strategies. So that you end up paying only the indispensable costs while availing any loan product, and no other additional charges due to negligence or improper planning.
Smart tips to avoid costly loans
- Scrutinise all fees before applying for any particular loan product.
- Use personal loan EMI calculators to confirm affordability.
- Avoid multiple loan or credit card applications within a short period.
- Opt for shorter repayment tenures if financially feasible.
- Employ prepayment and refinancing prudently after proper discussion with professionals.
A personal loan can be a lifesaver in emergencies, but only if treated as a well-planned financial step, not a quick escape. The traps of hidden charges, long tenures, multiple borrowings, and poor repayment planning can silently inflate costs. Borrow smart, read the fine print, and use repayment strategies.
For all personal finance updates, visit here.
Disclaimer: Mint has a tie-up with fintechs for providing credit; you will need to share your information if you apply. These tie-ups do not influence our editorial content. This article only intends to educate and spread awareness about credit needs like loans, credit cards, and credit scores. Mint does not promote or encourage taking credit, as it comes with a set of risks, such as high interest rates, hidden charges, etc. We advise investors to discuss with certified experts before taking any credit.