A personal loan may seem like a lifesaver during an emergency, whether it’s unexpected confinement in the hospital, losing a job, or a broken car. However, while it’s the most likely immediate solution to your financial needs, there are pros and cons when borrowing money from banks and lending institutions.
Access to personal loans is more accessible for those with a good credit history because most banks have promotional offers, allowing cardholders to borrow as much as their credit limit. What’s more, some lending institutions offer fast approval within 24 to 48 hours with less stringent requirements and paperwork, but the downside is that they offer higher interest rates than banks.
But how do you use personal loans to your advantage if you face unprecedented circumstances? As you deliberately think about getting a personal loan, check out the following to avoid bad debts and irresponsible borrowing.
1. Use it for emergency, not lifestyle wants
Building emergency savings is part of the fundamentals of being financially savvy. When an unforeseen event takes a toll on your finances, you still have reserves. Sadly, some banks promote personal loans as a solution to fund the next trip, a new gadget, or a celebration of a milestone.
Always remember that personal loans should be your last resort if the emergency funds have depleted already. Don’t spend just for the ‘gram’ and impress other people about your new gadget, appliances, or a grand celebration. Spend on lifestyle wants with extra cash instead of borrowing.
2. Avoid using it as an investment with poor ROI
Borrowing money for investments in stocks, bonds, and cryptocurrencies can backfire if the losses are higher than the monthly amortization you pay, resulting in a poor return of investment. Market volatility is inevitable, so better do your research before putting the eggs in seemingly attractive baskets.
Investments can be good or bad, depending on how you manage your loan. Solid risk management is necessary to avoid high losses. Moreover, steer away from get-rich-quick schemes that promise high interest rates. Invest what you can afford to lose. It can be your extra money or disposable income, not something you borrow, especially if you haven’t really established your emergency funds.
3. You will pay for service fees and other charges
You won’t just pay your monthly amortization, which differs from one bank to another according to the terms and conditions and effective interest rates (EIR). EIR is the actual cost of your personal loan, which includes service fees and other upfront charges for loan processing. That said, it’s higher than what banks advertised on their promos and deals.
Given that you pay for the monthly interest rate, ranging from 0.65% to 2%, some banks charge processing fees from P1,500 to P3,000 or more. If you borrow a loan amount exceeding P250,000, you need to pay the document stamp tax (DST) equivalent to P1.00 for every P250 of the loan amount.
What’s more, if you plan to pay using checks, returned checks have fees of about P1,000 to P2,000. So, be careful in issuing checks or better yet, choose another way to pay for your loans like enrolling in auto-debit arrangements and mobile banking.
4. Be aware of non-collateral and collateral loans
Non-collateral loans are unsecured loans that don’t require you to declare existing assets as your guarantee. These can also be informal personal loans you borrow from friends and family without interest, while some lending institutions offer these with a catch — like a high monthly interest rate. The advantage here is you get your money anytime quickly.
Meanwhile, collateral loans are the opposite. You borrow money in exchange for a guarantee and against the value of your total assets. For example, some banks offer secured loans where you can borrow 90% of the total deposit in your account. Other banks let borrowers access funds quickly through their credit cards, allowing cardholders to borrow against the value of the maximum credit limit.
5. Beware of 0% monthly interest rate and sketchy promos
Watch out for those too-good-to-be-true offers like 0% monthly interest or no collateral loans that let you borrow up to P2,000,000. While it’s a mystery how some lenders have access to mobile phone numbers, you have probably received text messages offering you these loans. Refrain from these unsolicited offers. You’d instead borrow from a legitimate bank or financial institution.
The monthly zero interest rate exists. CIMB Bank offers this fixed-term loan that lets you borrow for as minimum as P30,000 up to P50,000 for 12 months with zero percent interest. However, you need to pay 5% of the processing fee and other service charges like DST, and if you fail to pay on time, you will be charged 5% of the unpaid installment due or P300, whichever is higher. There are also requirements as well that are subject to approval.
6. Personal loans can either build or destroy your credit standing
Most banks require collaterals for new applicants, and if you are approved, it’s also your chance to build a good credit standing. Paying your dues on time is one way to keep your credit score on top.
In contrast, late payments and accumulated monthly charges can add red flags to your credit score. So, if this is your first time getting a personal loan, carefully consider the terms and conditions of the bank.
7. Personal loan isn’t for everyone
Now that you are armed with information about the basics of personal loans keep in mind that it’s not for everyone. Think of the purpose of the loan before getting one, compute for the monthly amortization, fees, and other charges.
If it’s intended for lifestyle wants, an upgrade to a new phone, gadget, or a big wedding celebration, it’s better to use your extra money rather than pay for stuff that may depreciate in just a few months.
If it’s intended for business and investment, work your way around the monthly interests and strive to grow your money, and invest only in those things you only know and where you are good at.
Overall, with the pros and cons of personal loans, we hope moneysmart folks like you can manage finances well if you avail a personal loan in the future.