Personal Loan Pitfalls: Don't Let Quick Cash Turn into a Big Crash!

Personal loans are a seemingly convenient solution offered by numerous banks, non-banking financial companies (NBFCs), and online platforms. With just a few clicks, you can receive instant funds into your bank account, with no questions asked and no collateral required.

Yet, beneath the surface of this apparent financial lifeline lies a web of pitfalls. This article enumerates those personal loan pitfalls for you so that you don't let quick cash turn into a big crash!

1. High Interest Rate/APR:

Personal Loans are unsecured, so the interest rates on such loans vary widely. While some lenders offer a comfortable interest rate of less than 10%, the commonly charged interest rate falls between the range of 13% p.a to 18% p.a. If your credit score is unfavourable, this rate can even go up to 40% p.a.

While the interest rates typically depend on your credit score, lenders are required to set rates within legal bounds.

Exercising caution is crucial when assessing Annual Percentage Rates (APR), as they can be manipulated. Instead, it is advisable to focus on evaluating the total repayment amount over the loan's duration, including interest, fees, and principal, for a more accurate understanding of its overall expense.

2. Additional Fees & Charges:

The second potential drawback of personal loans involves the extra fees and charges they come with. When you get a loan, you might have to pay processing fees right away, which are intended to cover the cost of setting up the loan.

Furthermore, if you're late with your payments, you'll also get hit with late fees, making your loan even more expensive.

Sometimes, there are other hidden charges that can surprise you, making your loan cost more than you expected. These extra fees add up fast and can make your loan much more expensive than you planned. Hence, checking for these fees before taking out a loan is important to avoid any surprises down the line.

3. Lack of Flexibility in Loan Repayment:

Most personal loan lenders offer limited to no options for repayment, leaving borrowers with no flexibility in the repayment when facing financial constraints. Fixed monthly instalment plans can prove burdensome during unexpected hardships, with no provisions for deferment or adjustment.

Additionally, most lenders do not allow borrowers to make pre-payments or foreclose the loan without pre-payment/foreclosure charges. Without the ability to renegotiate terms or explore alternative repayment schedules, borrowers may feel trapped in a cycle of financial strain. Hence, before taking a personal loan, it is advisable to check whether the lender offers flexible repayment options.

4. Can Create Unnecessary Debt:

While personal loans can be tempting due to their accessibility, they can quickly spiral into burdensome debt. Borrowers may succumb to the allure of quick cash without fully assessing their repayment capacity, leading to overborrowing and subsequent financial strain.

Moreover, high interest rates and hidden fees can inflate the total repayment amount, further increasing the debt burden. Without a clear repayment plan or budget in place, borrowers risk falling into a cycle of debt accumulation, struggling to keep pace with escalating payments.

What initially seemed like a convenient solution can turn into a long-term financial burden, eroding financial stability and undermining future goals.

5. Privacy Concerns:

Privacy Concerns are a big pitfall in online personal loans, echoing the prevalent threat of data breaches. In contrast, traditional banks adhere to stringent privacy regulations, and alternative lending platforms may not offer the same level of protection.

As cyber threats have become common today, entrusting sensitive personal and financial information to less regulated entities poses significant risks. While lending platforms ideally prioritise data confidentiality, there's no guarantee of security from breaches.

Prioritising a lender with a proven track record of trustworthiness becomes imperative when considering online loan applications. Scrutiny of a lender's reputation and commitment to safeguarding privacy can mitigate the risk of exposing sensitive data to potential exploitation, ensuring borrowers' peace of mind in an increasingly digitised lending landscape.

6. Strict Eligibility Criteria:

Lenders usually impose stringent personal loan eligibility requirements as these loans are offered without collateral. Factors such as credit score, income level, employment history, and existing debt obligations are often used to determine eligibility, leaving many potential borrowers marginalised if they do not meet all the eligibility criteria.

These restrictive criteria can especially impact individuals with limited credit history or irregular income streams, further worsening financial disparities. Consequently, those who fail to meet these stringent standards may find themselves excluded from accessing much-needed funds, hindering their ability to address pressing financial needs or emergencies.

7. Potential Credit Damage:

While providing immediate financial relief, these loans can adversely impact credit scores if mismanaged. Late or missed payments, defaulting on loans, or accruing excessive debt can tarnish credit histories, diminishing future borrowing opportunities and affecting interest rates on future loans.

Moreover, high credit utilisation ratios resulting from sizable personal loan balances can further affect credit scores. Individuals unaware of these risks may inadvertently sabotage their financial standing, facing challenges in securing housing loans or even landing employment opportunities.

Understanding the potential for credit damage underscores the importance of responsible borrowing practices, diligent budgeting, and timely repayment to safeguard long-term financial health and preserve creditworthiness.

8. Additional Insurance Cost:

Banks and non-banking financial companies (NBFCs) exert pressure to buy loan insurance against potential unforeseen setbacks that could hinder loan repayment. While offering protection, this mandatory insurance inflates the overall cost of borrowing, often without providing the required benefits to borrowers.

Faced with such demands, borrowers should exercise caution and assess whether the proposed insurance aligns with their needs. Opting to consult with a personal insurance agent allows for a comparative analysis of the lender's proposed insurance against alternative options.

By scrutinising the terms, coverage, and premiums offered by different insurers, borrowers can make informed decisions that minimise the additional financial burden imposed by mandatory loan insurance, ensuring that they aren't overpaying for unnecessary coverage.

9. Payday Loans:

Despite being marketed as short-term solutions, it is advisable to exercise caution against the use of payday loans due to their predatory nature. With sky-high interest rates, often reaching triple digits annually, borrowers find themselves trapped in a relentless cycle of borrowing and repayment.

The terms of payday loans frequently compel individuals to roll over their loans for additional terms. Succumbing to quick cash from payday loans can lead to long-term consequences, including worsening financial instability and credit damage. Avoiding these high-cost loans is crucial to safeguarding financial well-being and steering clear of the pitfalls inherent in payday lending.

10. Cashbacks and Offers:

Cashbacks and offers lure borrowers with enticing deals such as cashback incentives and payment holidays, presented as competitive advantages by lenders. However, borrowers must remain vigilant, recognising that these offers often conceal hidden costs.

Although initially appealing, these perks ultimately come at a price, with borrowers bearing the burden through higher interest rates or fees embedded within the loan terms. Despite the allure of short-term benefits, borrowers should scrutinise the long-term implications of such offers, ensuring they align with their financial goals and budget.

By being vigilant and understanding that lenders aim to profit from these promotions, borrowers can make informed decisions, avoiding the trap of falling prey to seemingly attractive but ultimately costly deals.

To conclude:

While personal loans can provide relief during financial crunches, it's crucial to approach them cautiously, and it requires careful consideration and awareness of potential pitfalls. By understanding the risks associated with personal loans, you can harness the benefits of personal loans while mitigating the associated risks, ensuring a smoother journey towards achieving your financial goals.

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KETKI JADHAV is a Content Writer at PersonalFN since August 2021. She is an MBA (Finance) and has over seven years of experience in Retail Banking. Ketki specialises in covering articles around banking, insurance, personal finance, and mutual funds and has been doing it for over three years now.

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This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.