Thinking of applying for your first loan? Confused by all the offers and sweet loan deals you keep seeing in the papers or online? Notwithstanding the type of financing facility you want to apply for (like a personal, home or vehicle loan), it’s very important that you do the due diligence before signing on the dotted line.
So, in a bid to help you make informed decisions, let’s take a look at some of the crucial aspects of taking a loan for the first time, and also discuss some prudent financial practices to ensure you make the most of the money you borrow.
So, Do You Really Need A Loan?
This has to be the first question you ask yourself when you’re thinking of applying for a loan. If it’s a home loan, you probably need it as a majority of people are unlikely to buy a home through their own savings. But if you’re thinking of a personal loan, you need to evaluate the situation more closely. Just because a bank tells you that you have a mega loan pre-approved especially for you, you don’t have to jump at it.
Let’s be clear: a loan is money that’s not yours. You have to repay what you borrow along with interest. For example, let’s say you’re taking a personal loan of Rs.3 lakh at 15% p.a. for a period of 5 years. The total interest you’ll end up paying over 5 years is more than Rs.128,000. That’s almost half of what you actually borrow!
So, it makes sense to also explore alternatives before taking a call. Can you borrow from your family? Do you have idle gold which you can put in as security to bring down your loan interest? Also, this is where you’ve got to distinguish between your ‘wants’ and your ‘needs’. If you’re going to borrow a lot of money for something you just want, like a lavish international holiday or an expensive gadget, it might be better to wait until you’ve saved up enough. It’s way more satisfying that way, apart from saving money on the interest outgo.
How Much Money Should You Borrow?
Once you’ve complete clarity on why you need the loan for, it’s time to evaluate how much money you should borrow. How much of it can you manage with your savings or investment returns? If you can fund a good portion of the expense with your own money, your loan amount and interest outgo will come down. Also, for something like a car loan, it’s very important that your choice of vehicle aligns with your budget. In other words, don’t go for a Rs. 15 lakh car loan (even if you’re eligible for that much loan amount) if you have a budget for a Rs. 8 lakh car.
How Much Loan Can You Afford?
How much you need may at times be very different from how much you can afford to borrow. To get a clearer answer to this, first calculate the monthly interest playout of the loan you want to take. Then calculate your monthly take-home salary or the net income, and pitch it against your fixed expenses (like rent, utility bills, fees, insurance premiums, SIPs, etc.), variable expenses (grocery, conveyance, etc.) and your existing debts (like credit card dues, etc.).
Ideally, your total debt should not exceed 50% of your net monthly income, which is called the debt-to-income ratio. This is to ensure you’re always left with sufficient funds to save up and invest to meet your financial goals without having to cut down on your regular monthly expenses.
So, if the new loan repayment will keep your debt-to-income ratio under 50%, you can go ahead with it. At times, you may want to reduce your loan amount in order to maintain your total debt at the 50% mark, which may involve waiting for some time till the time you’ve saved up for the shortfall amount.
Check Your Credit Score
It’s crucial that you have a credit score of at least 750 to ensure you not only get your desired loan approved but also get it with favourable repayment terms like a lower interest rate or without having to pledge any additional security. Lenders take your credit score seriously to assess your creditworthiness before disbursing a loan.
If your credit score is poor, you should work towards improving it before applying for a loan. You can do so by being disciplined with all the repayments of your existing loans (like credit card dues), never missing a repayment, correcting errors in your credit report (if any) and not applying for multiple loan applications in quick succession.
What To Remember When Choosing Your Loan
Now that you know why you should borrow and how much you should borrow, it’s time to consider these pointers to answer “from where should you borrow’ and “under what terms and conditions”.
Do your research thoroughly: There are plenty of loan options available in the market. Each one offers its own set of features and benefits. Take the help of an online platform to compare the various options you’re eligible for. Find out options that give you the lowest interest rates, best repayment options, and convenient tenures.
Choose the right interest rate: You may be asked to choose between a floating rate and a fixed rate. Floating rates are usually lower than fixed rates. But they change when the market rate changes. Fixed rates remain constant. Most borrowers choose floating interest rates.
Select your tenure wisely: Longer tenures will lower your EMIs. But you’ll pay more interest in total. Shorter tenures increase your EMIs, but you’ll pay lesser interest overall. Choose the ideal tenure based on your affordability.
Processing fees matter: The processing fee adds to the cost of your loan. So, factor in that as well when you choose your loan.
Read the loan agreement thoroughly: This is extremely important. Make sure you go through the entire loan agreement and know your loan terms and conditions. Find out about all the other charges and fees that the lender levies (like how much are the pre-closure and part-repayment charges?). See if there are any hidden charges. This will help you prevent unwanted penalties and surprises later. It may take a little time but it’s worth it.
Once you get the loan…
Once you get the money, use it wisely. Ensure you plan your monthly budget to accommodate the EMIs first. Pull back on other expenses for a while if required. Remember, every single EMI needs to be paid by the due date.
- If you’ve opted for the auto-debit facility, make sure that your account always has enough money for the EMI.
- Choose a lender that allows part prepayments. This way, you can prepay your loan if you have extra cash after a few EMI payments.
Being financially prudent is a good practice. And handling your first loan well can help you get better loans in the future. Use your first loan as a tool to build your credit score. You get the money you need, and you can shape your financial future by being disciplined with your repayments.
The writer is CEO, Bankbazaar.com