5 mistakes to avoid before applying for a personal loan

Updated: Apr 16, 2020 2:55 PM

Let's look at 5 mistakes we must avoid while applying for personal loan:

5 mistakes to avoid before applying for a personal loanWhenever you apply for any kind of loan, lenders check your creditworthiness by fetching your credit report from credit bureaus.

By Naveen Kukreja, CEO & Co-founder, Paisabazaar.com

Quick disbursal of funds, no restriction on end-usage, minimum documentation and no collateral requirement make personal loans a preferred credit option during unexpected financial emergencies. While applying for personal loans, borrowers often fail to pay attention to some of the crucial factors associated with it, leading to rejection of loan application. Let’s look at 5 mistakes we must avoid while applying for personal loan –

1. Not reviewing your credit report

Whenever you apply for any kind of loan, lenders check your creditworthiness by fetching your credit report from credit bureaus. Your credit score represents how responsibly you have behaved with credit in the past. Usually, a credit score over 750 is considered healthy by banks and other institutions. If a borrower’s credit score is lower than 750, her loan application is likely to be rejected. Some lenders practice credit risk pricing wherein they factor in applicant’s credit score for setting loan’s interest rates. In that case, a strong credit score may help you get loan offers at lower interest rates.

Reviewing your credit report before submitting a loan application can also help prevent any possible error from getting bypassed, which may pull down your credit score, leading to loan rejection. Make sure to report the errors, if any, to the concerned bureau and lender for getting the rectification done at the earliest.

2. Submitting direct applications to multiple lenders:

As soon as you submit loan application directly to lenders, they initiate credit report request from credit bureaus to evaluate your creditworthiness. Such lender initiated requests are termed as hard enquiries, and each of them gets listed in the enquiry section of your credit report. Submitting multiple loan applications within a short span of time can significantly reduce your credit score.

Instead of submitting direct personal loan applications, visit online financial marketplace to compare and choose the most suitable lender on the basis of your credit score, income and other eligibility parameters. While these marketplaces also fetch your credit report from the bureaus, such requests are considered as soft enquiries, which do not impact your credit score.

3. Not comparing amongst various prospective lenders:

Given that personal loan interest rate can range anywhere between 10.35%-24% p.a., it is prudent to visit online financial marketplaces to compare and choose the right loan product and lender based on your credit score, income and other eligibility criterion. Do not limit your comparison to just the interest rate. You must also factor in processing fee, prepayment charges and other applicable terms & conditions before zeroing in on any particular lender.

4. Ignoring your repayment capacity:

Lenders assess repayment capacity by computing your Fixed Obligation to Income Ratio (FOIR), i.e. the proportion of your existing income being consumed in debt repayments. As applicants having FOIR within 50-60% (including EMI of the new loan) are generally preferred by lenders, make sure you opt for a loan tenure whose corresponding EMI keeps your FOIR within this range. Borrowers with lower repayment capacity can opt for a longer repayment tenure to avail lower EMI amount. However, longer tenure would also imply higher overall interest outgo and hence, consider prepaying your personal loan whenever you have surplus funds. While doing so, ensure the overall saving in interest cost significantly outweighs the prepayment charges levied by your lender, if any.

5. Not considering alternative loan options:

Do not ignore alternative loan options, such as secured loan options including top-up home loans, loan against securities, loan against property and loan against FDs. Just like personal loan, these loans also do not have any end-usage restrictions and usually come with lower interest rates and longer tenure option than personal loans. For instance, existing home loan borrowers can opt for top-up home loans available at interest rates usually as low as 8% p.a. and tenure which may go up to 30 years, depending on the residual home loan tenure. Similarly, those who have sizeable long-term investments can consider availing loan against securities in order to meet their financial shortfalls at lower interest rates without selling their securities.

This is an investor education initiative by Paisabazaar.com

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