WHILE taking a personal loan to finance your needs is a good idea, if not handled well, these loans can even land you in a debt trap. Here are some mistakes that borrowers make while applying for personal loans:

Loan for buying luxury items

Personal loans carry very high interest rates, ranging from 11% to 24% per annum. Always avoid personal loans for financing luxury items or using it for recreational activities like going on a holiday or redecorating your home. Banks and non-banking finance companies (NBFCs) are not allowed to lend unsecured loans for investment in capital markets. Yet, many circumvent this rule by availing personal loans to finance speculative trading, especially during bull markets. This is a high risk proposition as a fall in the stock market can also erode your capital and affect your repayment capability.

Ignoring repayment capacity

Your loan repayment capacity depends on your day-to-day expenses, existing EMIs and long-term investment commitments. Not knowing your repayment capacity may lead you to opt for a shorter tenure with higher EMIs or an unnecessary long tenure with higher interest payout.

Not comparing features

As the interest rates and charges for the same loan amount with same credit score may vary widely, undertaking a proper market survey backed by good bargaining can save a lot of money in terms of charges and interest payment.

Applying with too many lenders

Whenever you make a loan application, the lender calls for your credit report from the credit bureaus. As each credit enquiry has a negative effect on your credit report, applying for loans with too many lenders within a short period may bring down your credit score.

Hiding your existing debts

Often borrowers deliberately under-report their existing debts in order to qualify for a higher loan amount. However, lenders would inevitably go through your credit reports before approving your loan application. Such wilful misinformation will erode your trustworthiness in the eyes of the lenders and may lead to the rejection of your personal loan application.

Not evaluating alternative loans

The interest rates on loan against securities, loan against FDs, gold loans and top-up loans are significantly lower than interest rates on personal loans. For example, interest rates on top-up loans and loans against securities usually range between 10% and 15%. Prefer loan against securities over personal loan if you have sizeable long-term investments in well-performing mutual funds and stocks.

Existing home loan borrowers should opt for top-up loans as they come with longer tenure and lower interest rates.

Not checking credit report

Banks and NBFCs retrieve your credit report from credit bureaus while approving personal loan applications or setting interest rates. This makes it all-important to check your credit report before applying for any loans and rectify the errors, if any, in them. These errors mostly occur when your existing or past lenders fail to update your loan repayments to credit bureaus.

The writer is CEO and co-founder, Paisabazaar.com