Personal Loan: 10 Common Mistakes to Avoid Before Applying

With the advent of digitalization, taking out a personal loan is within reach. Many banks, NBFCs and fintechs have made the personal loan process, from application to disbursement, completely online. The pre-approved offers have further simplified the process of obtaining a personal loan in less time.

However, before you take advantage of the pre-approved personal loan offer or apply to a bank/NBFC of your choice, you should be aware of the common mistakes that some applicants make. Avoiding these mistakes can help you get the most out of your personal loan. What are these mistakes and how can you avoid them? Let’s discuss.

Personal loan mistakes should be avoided

Take out a personal loan even if you don’t need it: From time to time, you will receive pre-approved personal loan offers from various banks, NBFCs and fintechs. You will receive these offers through emails, text messages, WhatsApp messages, through online banking, mobile apps, etc. You may even get marketing calls from financial institutions saying that the personal loan offer is only for a limited time, or that processing costs have been reduced. or waived, etc.

You may be tempted to take advantage of these offers even if you don’t need a personal loan. However, you should only apply for a personal loan when you need it. If you use the personal loan without needing it, you will ultimately pay high interest on it.

You may also be tempted to use personal loan funds to invest in stock markets where short-term risk is high. However, you should always invest your own money rather than borrowing money for long-term investments toward your financial goals.

Therefore, do not make the mistake of taking advantage of a personal loan just because it is offered, even without needing it. Only request it if you have a specific need.

Not checking your credit score or taking steps to improve it before applying: Before applying for a personal loan, check your credit score. If your credit score is 750 or higher, you are more likely to be approved. The higher the credit score, the better for you. With a higher credit score, you can negotiate with the bank for a lower interest rate, lower processing fees, a higher loan amount, a longer loan term, etc.

If your credit score is below 750, you should take steps to improve it. If possible, delay your loan application for a few months so you have time to work on improving your credit score. Some of the steps you can take include:

1. Pay existing loan EMIs and monthly credit card bills before or on time.
2. Maintain a credit utilization ratio of 30% or lower
3. Having a healthy mix of secured and unsecured credit instruments
4. Maintain a significant gap between two credit applications
5. Keep old credit cards to take advantage of their obsolescence, etc.

Don’t compare the offers of multiple banks and NBFCs before choosing one: Before applying for a personal loan from a particular bank or NBFC, it is important to compare the personal loan offers from multiple banks and NBFCs. A comparison helps you understand the interest rate offered, the loan amount, the various costs, any current offers, etc.

A comparison will help you select the best personal loan offer that suits your needs. Various aggregator websites/apps mention the features and benefits of personal loans from multiple banks and NBFCs for comparison.

Failure to check eligibility criteria: Every time you submit a personal loan application, the bank makes a difficult inquiry to access your credit profile and your score. A hard inquiry results in the credit score dropping by a few points. If you get multiple rejections from different banks/NBFCs for not meeting the eligibility criteria, it may become difficult for you to get a loan.

Therefore, it is essential to check the eligibility criteria before applying for a loan. Each bank and NBFC can set its own eligibility criteria for loans. However, the common criteria include the following

1. The minimum and maximum age for the applicant for a personal loan.
2. Whether salaried and self-employed persons can register or only salaried persons can register
3. The minimum monthly income for salaried employees and the annual income tax return (ITR) for self-employed persons.
4. Minimum educational qualification
5. Total work experience and minimum tenure with current employer.
6. Minimum credit score
7. List of cities whose residents can apply

Before applying for a personal loan, it is important to check your eligibility and compliance to avoid rejection.

Request a higher amount than you need: When you need a personal loan, calculate the exact amount you need to borrow. Taking out a personal loan for a higher amount than you need will lead to higher interest expenses. Moreover, a higher loan amount will result in a higher EMI, which can put pressure on your cash flows until the loan is repaid.

Keeping tenure higher or lower than optimal: When you apply for a personal loan, make sure that the loan term is such that the EMI suits your cash flows. If the elected term is shorter than required, it will result in a higher EMI. A higher EMI will put pressure on your cash flow. You will have to use money for other purposes to service the EMI.

Similarly, if the elected tenure is longer than required, it will result in lower EMI. A lower EMI means that the loan repayment will take longer, resulting in a higher interest payment. Therefore, you should choose the term of the personal loan carefully so that it is appropriate and not higher or lower than required.

Do not check personal loan conditions: You may have compared the different features and benefits of personal loans from multiple banks and NBFCs. Now that you have finalized a particular bank or NBFC, you need to check the personal loan terms and conditions of that bank/NBFC.

It will help you understand the amount you qualify for, the term, the interest rate, various fees, etc. Understanding all the terms before signing the loan agreement will help you avoid any nasty surprises later.

To make multiple applications at the same time to different banks and NBFCs: Every bank and NBFC has its own features and benefits for personal loans. As a result, it can be difficult to choose one over the other. If you have shortlisted more than one bank/NBFC for your personal loan application, you will have to apply for one at a time. You have to wait for the bank/NBFC to make a decision.

If the application is rejected, you can only submit the application to the next bank/NBFC. You must allow a considerable time gap between personal loan applications at two financial institutions.

Submitting multiple applications to different banks and NBFCs at the same time can negatively impact your credit score. Banks consider this as credit-consuming behavior and may reject your application.

Not evaluating your DTI ratio or repayment capacity: The debt-to-income ratio (DTI) measures the percentage of monthly income that goes towards servicing debt obligations (loan EMIs and monthly credit card bills). Banks and NBFCs consider a DTI ratio of 35% or lower as good for approving personal loans. Some banks and NBFCs may consider a DTI ratio of 36 to 50% for personal loans with additional terms and conditions such as higher interest rate, etc.

Before applying for a personal loan, make sure your DTI ratio is 35% or lower. If yes, this will increase your chances of the personal loan being approved. If the DTI ratio is higher, try to lower it before applying for a personal loan.

Not drawing up a budget and working out a payment plan: Before applying for a personal loan, you can use various online calculators to calculate the EMI that you have to pay based on the loan amount, interest rate, tenure, etc. Now that you know the EMI, analyze your monthly income and outflow of cash and check whether provision can be made for the EMI.

You can use a budgeting method such as 50/30/20 budgeting. It divides monthly income into three categories: wants (50%), needs (30%), and savings and investments (20%). Check whether the EMI provision can be made from the savings and investments category (20%). If not, consider whether certain expenses can be removed from the needs category to make room for the EMI.

Personal loans can help you achieve financial goals

Several banks, NBFCs and fintechs offer personal loans. However, if you avoid the common mistakes discussed above, your personal loan can be approved without any hassle and the disbursement will be made on time. Proper planning can help you determine the right loan amount and term, compare bank offers, meet eligibility criteria, save on certain fees, and make timely repayments. Personal loans can help you achieve important financial goals.

Gopal Gidwani is a freelance personal finance content writer with over 15 years of experience. He can be reached at LinkedIn.