If you’re looking for a personal loan but anxious about its drawbacks, worry not. A personal loan is an incredibly helpful financial tool especially during emergency cash requirements. It has its own set of major benefits as long as you manage it well. Understanding the possible risks of unsecured personal loans will help you make a smart decision before you avail one. In this guide, loan experts from CreditMantri walk you through the benefits and risks of unsecured personal loans, so you can make the right choice.
What’s the difference between a Secured and an Unsecured Personal Loan?
A secured loan requires you to provide collateral such as a house, car, or any other asset. In case you fail to repay the EMIs on time and do not oblige by the terms and conditions of the loan contract, the bank can claim your security collateral.
On the other hand, an unsecured loan is given on the basis of your creditworthiness. Here you don’t have to pledge an asset to the bank. The loan will be given to you on the basis for your credit score. You only need a good credit score for the bank to trust you with a loan.
Here are other differences between the two:
- The interest rates on unsecured loans tend to be a little higher than secured loans. Well that is because the amount of risk involved is higher in unsecured loans as compared to secured loans. Since no guarantee is provided the banks charge higher interest rates.
- The upper limit on the amount that you can borrow through an unsecured loan is usually lower than a secured loan.
When you compare secured loans, unsecured loans have some limitations on what you can use them for. The purpose of your unsecured loan must be clear and approved as well.
Let us see the Possible Risks of Unsecured Personal Loans:
- Early Pay Penalties
Imagine a salary hike or winning a lottery or inheriting a huge amount of money, you might think about paying out your personal loan in advance, right? Then sorry to burst your bubble, because it is not so easy.
However prepayment offered by the majority of lenders today. But, the twist here is that you’ll have to pay extra for prepaying your loan. Some banks might charge you a little more than others. But, when it comes to foreclosing an unsecured personal loan, prepayment charges are unavoidable mostly. Therefore make sure to inquire first hand regarding the prepayment charges before you take any decision. Read the loan terms and conditions carefully before signing up for it.
- High Interest Rates
Let’s say that you qualify for a personal loan and are offered one. But should you really go for it just because you are eligible? No. You should never take a personal loan just because it’s offered. Let’s explain this better.
The interest rates of unsecured personal loans are steep. Since, you do not pledge any collateral to the lender, the risk borne by the lender is high. To offset this, the lender charges high interest rates on the loan.
Interest rates vary based on several factors like your credit score, the loan amount, the loan period, etc. If you carefully choose then you can even get an unsecured personal loan for interest rates less than 10%. Credit scores also have a direct hand while determining the interest rate on your personal loan.
At the same time if you aren’t careful then that same interest rate could be sky high. So, you could end up with a high-cost personal loan that can tighten your other finances.
- Borrowing Debt to Pay Debt
Payday loan is a type of unsecured loan which is borrowed in a small amount on the condition that it will be repaid by the borrower when he receives his salary or the required fund elsewhere. This loan gives instant access to the loan amount so that the borrower won’t have to rely on anything else for the money and they can address their emergencies.
However the interest rates on such loans are slightly higher. That is why financial experts don’t recommend this option as it can be risky. Let’s say if unfortunately you lose your job or face a loss in your business then this could turn into a nightmare. While payday loans are recommended to meet an emergency, don’t fall into the habit of frequent payday loans, as they are risky and expensive.
- Fixed Interest Rates
The interest on the loan is calculated through the original payment schedule based on a fixed interest rate. So even if the interest rates change in the future then it wouldn’t matter as your interest rate of the respective loan is already fixed. Check the interest rate before accepting the loan offer and then sign the documents.
When to Opt for Unsecured Personal Loans?
Personal loan is proven advantageous in cases such as:
When you have a number of debts that are making it difficult to keep a track on them then a personal loan can help you consolidate it.
It simplifies your finances. You have to focus on paying off just one loan instead of going through the burden of paying off multiple loans. With this you don’t have to focus on multiple loan EMIs. You essentially combine all your EMIs into one. You can concentrate on repaying only one loan at a time by taking a personal loan.
Home renovation is a type of expense that is completely unavoidable. House renovation such as fixing the roof, water leakage from the walls, loose hinges of the window, etc. are a few things that need immediate attention as it could further damage. A personal loan can help you meet these unexpected domestic expenses.
When NOT to Opt for Unsecured Personal Loans?
Personal loan is not recommended for cases such as:
Indian weddings are known for their extravagance. No matter how well planned it is, they end up becoming a costly affair. Afterall weddings are one among the most important events of anyone’s life. Since you know that a wedding is in the cards in the future, you can start saving for it. Consider building a separate savings like a fixed deposit to meet the expenses of a wedding in the family. Since it’s not an unexpected event, personal loans should be the last option for marriage expenses.
Everyone loves a relaxing vacation time with friends and family. Vacations can be expensive, especially when there are several members. However, you don’t have to get a personal loan for it, since it’s not an unexpected or emergency event.
Loans may be offered easily but once your fun time is over, it’s payback time. This can take a toll on your finances and stress you out. No you don’t really need that. Plan your trip ahead and start saving now if you wish to go for a vacation. Open a Recurring Deposit and contribute to it frequently to make your dream vacation a reality.
You might need a loan at some point of your life. If you ever wish to take a personal loan then you will have to choose whether that’s going to be a secured or unsecured loan. As you know that unsecured loans are not a risk-free choice entirely, get it only when you are completely sure of it. Also ask yourself if you really need an unsecured personal loan than a secured personal loan.
While an unsecured personal loan may feel like an easy choice, make sure to weigh the pros and cons, consider the risks involved before you take one.