Personal Loan: 10 common mistakes to avoid before you apply | Mint

With the advent of digitisation, getting a personal loan is at your fingertips. Many banks, NBFCs, and fintechs have made the personal loan process from application to disbursement completely online. The pre-approved offers have further simplified getting a personal loan in less time. 

However, before availing that pre-approved personal loan offer or applying with a bank/NBFC of your choice, you should be aware of the common mistakes that some applicants make. Staying clear of these mistakes will help you make the most of your personal loan. So, what are these mistakes, and how can you avoid them? Let us discuss.

Personal loan mistakes to avoid

Taking a personal loan even when you don’t need it: From time to time, you will keep getting pre-approved personal loan offers from various banks, NBFCs, and fintechs. You will get these offers through emails, SMSs, WhatsApp messages, within net banking, mobile apps, etc. You may even get marketing calls from financial institutions saying the personal loan offer is for a limited time only, or the processing fee has been reduced or waived, etc.

You may be tempted to avail of these offers even when you don’t have a need for a personal loan. However, you should apply for a personal loan only when you need it. When you avail of the personal loan without the need for it, you will end up paying high interest on it. 

You may also be tempted to use personal loan money for investing in stock markets where the risk is high in the short term. However, you should always invest your own money rather than borrow money for long-term investment towards your financial goals.

Hence, don’t make the mistake of availing a personal loan just because it is being offered, even without needing it. Apply for it only when you have a specific need for it.

Not checking your credit score or not taking steps to improve it before applying: Before applying for a personal loan, you must check your credit score. If your credit score is 750 or higher, the chances of approval are higher. The higher the credit score, the better for you. A higher credit score allows you to negotiate with the bank for a lower interest rate, a lower processing fee, a higher loan amount, a higher loan tenure, etc.

If your credit score is lower than 750, you must take steps to improve it. If possible, postpone the loan application by a few months, giving you time to work on improving your credit score. Some of the steps that you can take include:

1. Paying existing loan EMIs and credit card monthly bills before or on time.
2. Keeping a credit utilisation ratio of 30% or lower
3. Having a healthy mix of secured and unsecured credit instruments
4. Keeping a decent gap between two credit applications
5. Retaining old credit cards to benefit from their ageing, etc.

Not comparing the offers from multiple banks and NBFCs before choosing one: Before applying for a personal loan with a particular bank or NBFC, comparing the personal loan offers from multiple banks and NBFCs is important. A comparison helps you understand the interest rate offered, the loan amount, various charges, any ongoing offers, etc.

A comparison helps you select the best personal loan offer that suits your requirements. Various aggregator websites/apps list the personal loan features and benefits from multiple banks and NBFCs for comparison.

Not checking the eligibility criteria: Whenever you make a personal loan application, the bank does a hard inquiry to access your credit profile and score. A hard inquiry results in the credit score dipping by a few points. If you face multiple rejections from various banks/NBFCs due to not meeting the eligibility criteria, it may become difficult for you to get a loan.

Hence, checking the eligibility criteria before applying for a loan is essential. Every bank and NBFC can decide their own eligibility criteria for loans. However, the common criteria include the following

1. The minimum and maximum age for the personal loan applicant.
2. Whether salaried and self-employed can apply or only salaried can apply
3. The minimum monthly income for salaried individuals and annual Income Tax Return (ITR) for self-employed individuals.
4. Minimum education qualification
5. Total work experience and the minimum tenure with the current employer.
6. Minimum credit score
7. List of cities whose residents can apply

Before applying for a personal loan, checking the eligibility criteria and whether you meet them is important to avoid rejection.

Applying for a higher amount than you need: When you need a personal loan, assess the exact amount you need to borrow. Taking a personal loan for a higher amount than you need will lead to higher interest outgo. Also, a higher loan amount will result in a higher EMI that may pressure your cashflows until the loan is repaid.

Keeping the tenure higher or lower than the optimum: When applying for a personal loan, ensure that the loan tenure is such that the EMI suits your cashflows. If the tenure chosen is lower than required, it will result in a higher EMI. A higher EMI will put pressure on your cashflows. You will have to divert money from other purposes towards servicing the EMI.

Similarly, if the tenure chosen is higher than required, it will result in a lower EMI. A lower EMI means the loan repayment will go on for a longer duration, resulting in higher interest payment. Thus, you need to choose the personal loan tenure carefully, such that it is just appropriate, neither higher nor lower than required.

Not checking the personal loan terms and conditions: You may have compared the various features and benefits of personal loans from multiple banks and NBFCs. Now that you have finalised a particular bank or NBFC, you must check the personal loan terms and conditions of that bank/NBFC.

It will help you understand the amount you are eligible for, the tenure, the interest rate, various charges, etc. Understanding all the terms and conditions before signing the loan agreement will help you avoid any nasty surprises later.

Making multiple applications with various banks and NBFCs at the same time: Every bank and NBFC has its own personal loan features and benefits. As a result, it may be difficult to choose one over the other. In case, you have shortlisted more than one bank/NBFC for your personal loan application, you should apply with one at a time. You should wait till the bank/NBFC gives its decision.

If the application has been rejected, only then you should go ahead with the application with the next bank/NBFC. You should maintain a decent time gap between personal loan applications with two financial institutions.

Making multiple applications with various banks and NBFCs at the same time can impact your credit score negatively. Banks consider it as credit-hungry behaviour and may reject your application.

Not evaluating your DTI ratio or repayment capacity: The debt-to-income (DTI) ratio measures the percentage of monthly income going towards servicing debt obligations (loan EMIs and credit card monthly bills). Banks and NBFCs consider a DTI ratio of 35% or lower good for approving personal loans. Some banks and NBFCs may consider a DTI ratio of 36 to 50% for personal loans with additional terms like higher interest rate, etc.

Before applying for a personal loan, you must check whether your DTI ratio is 35% or below. If yes, it increases your chances of the personal loan getting approved. If the DTI ratio is higher, work towards bringing it down before applying for a personal loan.

Not preparing a budget and working out a repayment plan: Before applying for a personal loan, you can use various online calculators to calculate the EMI you need to pay based on the loan amount, interest rate, tenure, etc. Now that you know the EMI, analyse your monthly cash inflows and outflows and check whether a provision can be made for the EMI.

You can use a budgeting method like 50/30/20 budgeting. It allocates the monthly income towards three categories: Wants (50%), needs (30%), and savings and investments (20%). Check whether the EMI provision can be made from the savings and investments category (20%). If not, check whether certain expenses can be cut from the needs category to make room for the EMI.

Personal loans can help achieve financial goals

Several banks, NBFCs, and fintechs offer personal loans. However, if you avoid the common mistakes discussed above, your personal loan can be approved in a hassle-free manner, and the disbursal will be timely. Proper planning can help you decide the appropriate loan amount and tenure, compare offers across banks, meet the eligibility criteria, save on certain charges, and make timely repayment. Personal loans can help you accomplish important financial goals.

Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.