9 things to look out for when taking out personal loans
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| What you need to consider before getting a personal loan | |||
| How much do you need to borrow? | Below $20,000 | $20,000 to $60,000 | $60,000 and above |
| Loan tenure | Less than 1 year | 1-5 years | 5 years or longer |
| Interest rate payable | Always look at the Effective Interest Rate (EIR) | Term | Revolving |
| Is it the best choice for your financial needs? | There are other alternatives available | I'm using the loan to purchase non-essentials | I've checked all avenues and this is the best option for my pressing needs right now |
As you can see, there are two types of personal loans — term and revolving.
Term personal loan
Should you need at least one year to finish repaying the personal loan in full, taking a term personal loan might be the smarter choice. The interest rate for a term personal loan is much lower, but if you want to make an early full repayment, there will likely be a penalty.
Revolving personal loan
Should you be confident to repay the loan promptly, but need quick cash to bridge a short-term gap, a revolving personal loan might do the trick. The interest rates can be as high as 20 per cent p.a., but you won’t be penalised for early full repayment. Hence, the total interest you pay could be much lower than that of the term personal loan.
The key differences between a term and revolving personal loan:
| Term | Revolving | |
| Interest rate | Lower | Higher |
| Repayment period | Fixed | Minimum monthly repayments but usually no fixed period for repayment |
| Penalty for early full repayment | Yes | No |
Next, consider how much you can afford/need to borrow and your loan tenure. There's no point taking out the maximum loan (i.e. 4 times your salary) when you don't need to. Don't forget, you'll need to pay the interest as well, and that value goes up correspondingly with the amount you borrow.
Calculate how much you actually need to borrow, and how long is realistically comfortable to complete the loan repayments. There's really no point dragging out the loan tenure for 5 years (and acquiring more interest) when you can easily pay off the loan in 2 years or less.
Example: Tan earns $4,000 a month, and wants to borrow $20,000. If he takes a term personal loan at 8 per cent p.a. EIR:
| Loan tenure: 12 months (1 year) Monthly repayments: $1,739.77 Total interest payable: $877.22 |
| Loan tenure: 60 months (5 years) Monthly repayments: $405.53 Total interest payable: $4,331.67 |
Finally, ask yourself: Is this loan truly necessary? Can you postpone this expense? If the loan is for a want rather than a need, here are things to look out for to not incur incessant debts and run the risk of damaging your creditworthiness.
9 common mistakes when taking out a personal loan
1. Underestimating the significance of your credit score
As mentioned before, your credit score plays a crucial role in loan approvals and interest rates, acting as your financial report card. Before applying, always check your credit score by filling out an application with the Credit Bureau of Singapore (CBS) to get a clear overview of your current credit situation. Ask CBS for further assistance should you need to improve your credit score.
Note: Obtaining a credit report incurs a cost of S$8 (excluding GST), plus potential extra fees for specific delivery options. However, if you've recently applied via a CBS member institution, you can access it at no charge.
2. Submitting multiple credit card or loan applications
Applying for several loans or even credit cards simultaneously can lower your credit score, 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 (i.e. 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 seems 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. 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.
Interests on a larger loan amount will then compound, leading to even higher liabilities over time. Moreover, a larger loan can increase your debt-to-income ratio, which negatively affects your credit score.
5. 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.
6. 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.
7. 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, ultimately negatively impacting your credit score.
8. Having no estimated repayment plan in mind
Applying for a personal loan without a concrete repayment plan has several 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 (again) severely damage your credit score and financial reputation in both the short or long term.
9. 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 per cent of your income as per the latest data from the Monetary Authority of Singapore (MAS).
As such, 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 per cent TDSR limit.
Closing thoughts — Is taking a personal loan the right decision for you?
Personal loans can be a valuable financial tool when used responsibly. However, it's crucial to weigh the pros and cons carefully.
Before taking out a personal loan, consider the following:
- Do you truly need the loan? Is it for a necessary expense or a want?
- Can you afford the monthly payments? Assess your budget and ensure you can comfortably repay the loan.
- Have you compared different loan offers? Shop around to find the best interest rate and terms.
- Do you have a solid repayment plan? Set a clear budget and stick to it.
- Is your credit score healthy? A good credit score can help you secure better loan terms.
By carefully weighing on these factors, you can make informed decisions about whether a personal loan is the right choice for your financial situation.
If you've considered all the factors and are certain that a personal loan is the right choice, start by checking out the best personal loan bank interest rates.
