1) Types of personal loan
Just like other types of loans, personal loans can be classified as either secured or unsecured.
Secured personal loans are ideal if you do not have an impressive credit score. You will have to pledge assets as collateral in the form of a property or investments to lenders as guarantee. In return you will be rewarded with a lower interest rate and a relatively larger borrowing amount. It also has a longer repayment period, offering you enough time to pay your dues on time since the alternative is the risk of losing your asset.
For people with a great credit score, unsecured personal loans may be the way to go, as they are much more convenient because no collateral is required and the approval process is much faster. You also have the flexibility of being able to choose the term of your loan to suit your needs. The trade-off is that these facilities will cost you a higher interest rate when compared to secured loans, and the borrowing amount will also be lower.
2) Understand the loan process
Review your credit score before making a loan application, because having a reasonably good credit score will help qualify you for better interest rates.
Moreover, don’t hesitate to ask the lender about the entire application process for the loan in detail. Ask about things such as how long it will take to process the loan and when you will receive the borrowed amount from the bank. Ask the lending bank if it is possible to apply for the loan online, as some banks do allow online applications as long as you can provide proof of identity and income. However some banks that are more strict may require you to bring tax returns or copies of bank statements so that you can prove how much money you make and how many assets you have.
3) Interest rate charged
Personal loans come with the advantage of having a fixed interest rate, thus they come with less uncertainty and risk. When you are hunting for personal loan, make it a point to compare the Annual Percentage Rate (APR) of each bank instead of the conventional interest rate. This is because APRs give the true value for comparison as it includes arrangement fees.
Besides this, take great care to look out for whether your loan is subject to simple interest or pre-computed interest. For a simple interest loan, interest is only calculated based on the principal amount and multiplied by the number of periods.
In a pre-computed loan, the finance charge is calculated and added to the balance up front. So for example, if the principal amount is RM10,000 and the finance charge is calculated to be RM3,000, then you owe the lender RM13,000 in total. If you pay off your balance early, then an interest refund is calculated using the Rule of 78. Which is an unnecessarily complicated way to pay a loan and make you pay more interest up-front.
So don’t be afraid to ask your lender whether the loan is a simple interest loan or a pre-computed interest loan. If it’s the latter, feel free to walk away, as you stand little to gain from it, especially if you plan on paying off your loan earlier than the maximum term.
4) Time frame of payment
The vast majority of personal loans have a fixed repayment period attached to them, which gives you the scope to plan ahead and manage your expenses.
In general, the longer the repayment term, the lower the monthly payment required, but this comes at the expense of a higher interest cost in the long run.
With shorter repayment terms come higher monthly payments, but the total interest paid will ultimately be lower when compared to loans with long repayment terms. So if you can afford the higher monthly payments, it is generally advised that you take this route, because it will save you money in the long run. However if your budget does not allow for it, then you should go with the longer repayment term.
5) Pre-payment penalties
This is the trickiest part of personal loan. You are convinced by the lenders that you can decide the “when” and “how” of the payments. In fact, you can save your money to pay off your loan early, this may seem like the most viable option for you. However, often the lenders do not disclose that they may charge a compensation fee for early payment. So, remember to ask your lender whether there is a prepayment penalty as you should avoid this charge at any cost.
6) Consequences of default
Loan default is a nightmare that haunts every borrower. It can be the result of missing a payment, being late on a payment or avoiding a payment altogether. Regardless, it is a worst case scenario for sure. When a secured personal loan defaults it will simply result in the seizure of the asset you put as your collateral. This will deeply damage your credit report and at the same time you’ll lose a valuable asset too.
Scary as that may be, defaulting on an unsecured loan can bring even more dire consequences. The bank may hire a collection agency to try and get their money back. They will use persistent and sometimes aggressive ways to squeeze the money out of you as they have a financial stake in it. Eventually, you could be dragged to court and be forced to pay your debt and bear the legal fees. This will not only leave a permanent scar on your credit report but it may also have negative effects on your personal and business reputation.
7) Insurance charged
If the lender tries to make you buy payment protection insurance (PPI) along with your loan, don’t fall for it. Some would also try to convince you to purchase life insurance or unemployment insurance with misleading words. However, it is always better to keep the loan and insurance separate as many of these tag along policies are not adequate or don’t pay out at all.
Do your own research before making any decisions and weigh your options properly. Keep the above tips in mind to avoid making mistakes when taking out a personal loan that may turn out to be costly in the long run.