When Should You Take a Personal Loan?

Personal loans have become a popular choice for many in India, offering quick access to funds without needing to pledge collateral. They can be a lifesaver in times of need, but they also come with certain responsibilities. While it's tempting to take out a personal loan to manage unexpected expenses or achieve financial goals, it’s crucial to assess the timing and necessity before taking the plunge. 

In this blog, we’ll explore when it makes sense to opt for a personal loan and when you should think twice, all within the Indian context.

Understanding Personal Loans in India

Personal loans in India are unsecured loans that don’t require you to pledge any asset as collateral. They are typically available for a wide range of purposes, from medical emergencies and weddings to consolidating debt and funding a holiday. These loans can be availed from banks, Non-Banking Financial Companies (NBFCs), and fintech companies, making them easily accessible to a vast section of the population.

However, since personal loans come without any security, they often attract higher interest rates compared to secured loans like home loans or car loans. The interest rate typically ranges from 10% to 24% per annum, depending on your credit score, income, and repayment capacity.

When Should You Take a Personal Loan?

While personal loans can be helpful in many scenarios, it’s essential to be aware of when they are actually beneficial. Here are some of the most common and justifiable reasons to consider a personal loan:

Medical Emergencies

Medical emergencies can strike without warning, and often, health insurance coverage may not be enough to cover all costs. This is one of the most justified reasons to opt for a personal loan. In India, with rising medical inflation and the cost of advanced treatments, a personal loan can help manage hefty hospital bills, surgery costs, and post-treatment care expenses without depleting your savings.

Key Tip: Before opting for a personal loan, check if your insurance covers the required amount. Opt for a loan only for expenses not covered by your policy.

Debt Consolidation

Debt consolidation refers to combining multiple loans or credit card debts into one loan, often with a lower interest rate. This is particularly beneficial if you're juggling several high-interest debts like credit card dues. In India, credit cards can charge interest rates as high as 36% per annum, whereas a personal loan may offer a lower rate between 10% and 15%, helping you save on interest and streamline repayments.

Key Tip: Make sure the interest rate on the personal loan is lower than your existing debts to truly benefit from debt consolidation.

Home Renovation or Improvement

For many Indians, owning a home is a dream come true, but maintaining or improving it can be expensive. Whether it’s renovating your kitchen, installing solar panels, or making necessary repairs before the monsoon season, a personal loan can offer the funds required to enhance your living space. Home improvement loans often have more stringent approval processes, making personal loans a convenient alternative.

Key Tip: Evaluate whether you really need the renovations or improvements at the moment, and ensure that the loan amount will significantly add value to your property.

Funding Big Life Events: Weddings or Higher Education

India is known for its grand weddings, but these celebrations can come with hefty price tags, sometimes running into lakhs of rupees. Similarly, funding your child's education abroad or in a prestigious Indian institution can be an expensive affair. While it’s tempting to dip into your savings or investments, a personal loan could be a more practical option, ensuring your long-term savings are not depleted.

Key Tip: For weddings or education loans, make sure that the event or course justifies the loan amount. Opt for a personal loan only if other options like scholarships or specific wedding/education loans are not viable.

Urgent Purchases or Repairs

Unexpected repairs, whether it’s your car breaking down or a major household appliance like a fridge or washing machine malfunctioning, can drain your finances. A personal loan can be a good option when you need to make urgent purchases or repairs and don’t have the cash to cover the expense. Since these expenses can’t usually be deferred, a personal loan provides immediate relief.

Key Tip: Ensure the urgency is real. If the purchase can be delayed or if you can save up for a few months, avoid taking the loan.

When Should You Avoid Taking a Personal Loan?

While personal loans can be a useful tool, there are certain scenarios where it’s better to avoid taking one. Here are some situations where a personal loan might not be the best option:

To Fund Lifestyle Expenses

In today’s age of consumerism, it’s easy to be swayed by luxury purchases such as gadgets, vacations, or high-end lifestyle products. However, taking a personal loan to fund these non-essential expenses can lead to long-term financial strain. It’s essential to differentiate between needs and wants before borrowing money.

Key Tip: If you can’t afford a luxury item with your current savings, it’s better to wait or save rather than taking on unnecessary debt.

To Invest in High-Risk Ventures

It might seem tempting to take a personal loan to invest in stock markets, cryptocurrency, or speculative real estate. However, since these investments come with significant risks, using borrowed money could lead to financial distress if the investment doesn’t yield the expected returns. In India, where markets can be volatile, such risks are amplified.

Key Tip: Never borrow money to invest in high-risk instruments. Use only your disposable income for speculative investments.

To Clear Existing Loans with Higher Interest Rates

It might seem like a good idea to take out a new personal loan to pay off an older loan with a high interest rate. However, this strategy could backfire if you end up with a higher interest rate on the new loan. Moreover, multiple loans can strain your credit score, making it harder to borrow in the future.

Key Tip: Opt for refinancing or negotiating with your existing lender for better terms instead of piling up personal loans.

Unstable Job Situation or Irregular Income

If your job situation is unstable or your income fluctuates, it’s advisable to avoid taking personal loans. In the current economic climate, where layoffs and pay cuts have become more common, especially post-pandemic, it's crucial to ensure that you have a stable income before committing to fixed monthly payments.

Key Tip: Wait until your income stabilises or build an emergency fund before considering taking a personal loan.

How to Ensure You’re Ready for a Personal Loan

If you’ve evaluated your situation and believe that a personal loan is the right choice, here are a few steps to ensure you're ready:

- Check Your Credit Score: A good credit score (above 750) ensures you get better interest rates and faster approval.

- Compare Lenders: Don’t settle for the first loan offer. Compare interest rates, processing fees, and tenure across multiple banks and NBFCs.

- Plan Your Repayments: Use online personal loan calculators to estimate your EMI and ensure you can comfortably afford it without stretching your finances.

- Read the Fine Print: Understand all terms and conditions, including prepayment charges, processing fees, and late payment penalties.

Conclusion

A personal loan can be a financial tool that offers convenience and flexibility, but it also comes with the responsibility of timely repayment. Whether you’re dealing with a medical emergency, planning a major event, or consolidating debt, timing and necessity are key. Assess your financial situation carefully, ensure you have a stable income to meet your EMIs, and only opt for a loan when you have a legitimate need.

By being aware of when to take a personal loan and when to avoid it, you can navigate your financial journey smoothly while achieving your personal goals without unnecessary stress.