Are you planning to take a personal loan? Just wait a moment before saying “yes”. Understanding the purpose of use is very important. Although these personal loans have many advantages, they don’t come cheap. Hence, proper consideration is required before you opt for one.
In Singapore, you could be settling dues for such loans at effective interest rates of 8% to 15%, which could be considered quite high when compared to certain other loan products. If you are not using a personal loan for the right reason, not only could your cost of borrowing be very high, you could also be looking at the possibility of debt accumulation.
So, what are some of the popular reasons for taking such loans in the country? Let’s find out.
Reasons for Getting a Personal Loan
According to a recently conducted survey, people take these loans for:
- Education (24%)
- Credit card repayment (23%)
- House renovation (16%)
- Emergency fund (15%)
- Investment (13%)
- New home (11%)
- New car (10%)
- Business (9%)
- Travel (6%)
- Medical bills (3%)
Although the Financial Stability Report, published by the Monetary Authority of Singapore (MAS) in November 2017, had shown that the quality of household balance sheets is improving, it also highlighted the fact that the spectre of high household debt continues to affect the economy.
Another recent study has shown that credit cards and personal loans form 21% of total household debt. Let’s not forget that high debt burden cannot only affect your purchasing power but can also slow down the economy in the long run.
Can something be done to address this issue by altering the way personal loans are used? Here are some tips on personal loan use that should help you along the way.
Personal Loans are not great for:
- Education: If you want to take a loan to join your dream university, just remember that an education loan may be a better alternative to a personal loan. While EIR on these loans could range between 8% and 15% p.a., education loans could charge you EIR in the range of 5% to 10%. Moreover, you can also find loans that require you to make repayments after you have graduated or landed a job. The interest is calculated accordingly. But, with a personal loan, interests will be calculated from the first month itself.
- Credit card repayment: While debt consolidation plans or balance transfers could charge low rates of interest, you may discover on closer scrutiny that the published rates don’t apply in your case. Instead, try to tackle credit card debt using tried and tested methods like debt snowballing or debt stacking. Cut down on your discretionary spending and channel a portion towards payment of these debts.
Alternatively, try to negotiate a deal with your bank and see whether they’re willing to settle for a smaller amount. Debt consolidation is only effective if you can pay off your dues within the introductory period or when promotional rates apply. If not, you’ll have to pay much higher rates, something which practically defeats the purpose.
- Speculative investments: Speculative investments, although rewarding if they work out, have an element of high risk. Taking a line of credit to invest in company shares or government bonds is definitely not recommended. If you lose money in speculation, you are not only suffering a notional loss but also jeopardizing your financial standing and ability to repay your loan. Once you get trapped in debt, freeing yourself could be a challenge. It will not only affect your financial health but also your emotional well-being.
- Home renovation: A home renovation loan in Singapore is usually offered by a traditional lender at effective interest rates in the range of 4% p.a. to 8% p.a. Contrast it to the average EIR rates on personal loans. Even though the vetting process may be more elaborate and time-consuming, it is worth the effort because you have to pay much less in interests. You may be able to find loans that let you borrow more than personal loans.
- For making down payment necessary for taking a house loan: HDB loans are currently available at 2.6% p.a. rate of interest. Currently, home loans offered by banks in Singapore are available under 2% p.a. DBS, for example, charges a premium of 1.45% over its fixed deposit home rate for 8 months (FHR8), which currently stands at 0.2% p.a.
However, most loans won’t cover the full cost of your property. You’ll receive up to 70% to 80% of the total cost, unlike HDB loans. But, taking personal credit to cover the remaining amount may not always prove to be a sound financial decision because taking multiple loans at the same time can make you overleveraged and affect your credit score.
- For buying a new car: Car loans are usually available at effective interest rates of 5% p.a. to 7% p.a. While it’s true that you may only be able to borrow up to 60-80% of the open market price of your vehicle, you can save a lot in interest payment. Using your own funds to cover the remaining amount will make more sense rather than opting for a personal loan.
A personal loan is however great for meeting your short-term financial needs. If you know how to manage them well, you can improve your credit score and get real value for money.