Common Mistakes To Avoid When Taking Personal Loans

Taking out a personal loan is a significant financial decision that can serve as a way provide much-needed funds, whether it's consolidating debt, financing a large purchase, or covering an emergency expense. However, rushing into a personal loan without careful planning and consideration can lead to unforeseen expenses. This could result in higher overall costs than you initially anticipated.

Here are some useful tips to help you avoid making mistakes with your personal loan, such as choosing unfavorable terms or borrowing more than you can afford to repay, which can escalate your financial burden in the long run.

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10 Don’ts For Personal Loans

1. Underestimating the significance of your credit score

Your credit score plays a crucial role in loan approvals and interest rates, acting as your financial report card. Before applying for a personal loan, always review your credit score and take steps to improve it if needed. A lower credit score can result in higher interest rates and may even lead to loan rejection.

2. Submitting multiple credit card or loan applications

Applying for several loans or even credit cards simultaneously may lower your credit score by a few points, and it will trigger multiple hard inquiries by lenders. Multiple hard inquiries in a short period can have a significant impact (usually more than 12 months) especially if they are for different types of credit (e.g., applying for several credit cards at once).

Instead of applying to multiple banks or lenders at once, conduct thorough research and choose the lender that best meets your needs.

3. Selecting a shorter loan duration for large amounts

While a shorter loan term may seem appealing for its quicker repayment, it typically results in higher monthly payments. When taking out a large loan, consider the loan duration to better manage your payments.

4. Charging most of your Payments To Instalment Payment Plans (IPPs)

Banks and MAS-authorised lenders assess your ability to repay loans by looking at your monthly financial commitments. High monthly payments towards IPPs can reduce your disposable income, making banks and lenders wary of your ability to handle additional loan payments. They may see this as a sign of financial overextension, making them hesitant to approve new personal loans which you may be keen on applying for.

5. Borrowing more than what is needed

When you borrow more, you incur higher interest over the life of the loan. This means you'll end up paying back significantly more than the amount you actually needed. Compounding Interest: The interest on a larger loan amount compounds, leading to even higher costs over time. Moreover, a larger loan can increase your debt-to-income ratio, which negatively affects your credit score.

6. Rushing into a “great” offer

By quickly taking up the first personal loan offer from a bank, and not comparing multiple offers first may result in you ending up with a loan that has a higher interest rate than necessary.

Different lenders offer varying rates, and shopping around can help you find the best deal as some loans may offer initial low rates that increase over time, and comparing fixed versus variable rates from different lenders can prevent future financial surprises. You can even tap on tools like MoneySmart’s personal loans comparison portal to speed up the process.

7. Not checking your credit report regularly

Knowing your credit score allows you to gauge your eligibility for personal loans by keeping track of outstanding debts and ensure that you do not overextend yourself when taking on new debt. In Singapore, credit reports are generated by Credit Bureau Singapore (CBS), and you can assess it online or at SingPost for a few (you may refer to our blog article here for more details).

Although a credit report is a useful tool for us to monitor our financial health, it plays a critical role for credit providers as well. Most banks and MAS-authorised lenders review your credit file to evaluate your creditworthiness before deciding whether to extend any credit to you, such as a personal loan.

8. Missing your payments

Since the CBS maintains credit reports and scores, banks and MAS-authorised lenders in Singapore will refer to these reports when assessing your loan applications. Thus, any missed payments by you such as late credit card bill payments, will be reported to CBS and be reflected in your credit report, and may ultimately negatively influence your CBS credit score.

9. Having no estimated repayment plan in mind

Applying for a personal loan without a clear repayment plan can have several negative consequences, such as increased risk of missing payments or defaulting on the loan thereby increasing your debt-to-income ratio, making it harder to obtain credit in the future. This may severely damage your credit score and financial reputation in the short term or long term.

10. Getting a personal loan before a home loan

Banks will usually examine your financial history and existing debt to determine your Total Debt Servicing Ratio (TDSR), which must not exceed 55% of your income as per the latest data from the Monetary Authority of Singapore (MAS). Therefore, if you're planning to get a new home soon, purchasing a car or obtaining a personal loan before applying for a home loan could push you over the 55% TDSR limit.

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Frequently Asked Questions

Is a repayment plan good to have before applying for any personal loans?

Having a repayment plan in place before applying for a personal loan is crucial for both securing the loan and managing it effectively. It demonstrates to lenders that you are a responsible borrower, improves your chances of approval, helps secure better loan terms, ensures manageable payments. If you apply for a personal loan without a clear repayment plan, it can have several negative consequences, such as increased risk of missing payments or defaulting on the loan.

Does my credit score affect my personal loan application?

Yes. Your credit score is a crucial factor in the personal loan application process, influencing approval chances, interest rates, loan amounts, terms, and fees. Maintaining a good credit score can significantly enhance your ability to secure favorable loan conditions and reduce borrowing costs. Therefore, it's essential to monitor and improve your credit score.