Personal loan pros & cons, and 5 things you should never use them for

A personal loan may seem like a possible solution to our immediate financial concerns during this trying Covid-19 outbreak.

In a 2020 MoneySmart survey on personal loans, we found that job security and cash flow remained the key financial stressors during the Covid-19 period. Many were looking at meeting immediate household expenses and saving for emergencies during this time.

People are looking for more cash liquidity to deal with uncertainty, and 65 per cent of respondents are looking at taking out personal loans between $20,000 to $29,000. One key factor remained consistent: Low-interest rates still matter.

I, too, found myself browsing bank websites such as DBS, POSB and Citibank just to look at the best personal loan interest rates - just in case my resources run dry.

We are facing a global pandemic, and it's not easy.

I've personally seen those around me get retrenched, their companies go bust; my husband and his colleagues were put on no-pay leave; my job-seeking friends are on the brink of despair as their bank balance dries up.

It's hard for some of us to even make ends meet, especially if we have a family to support and financial commitments to upkeep.

Personal loan queries on the rise since Covid-19

Thank goodness for the cash payouts from the government. But sometimes, it's not quite enough.

Some of us might be turning to various channels (such as banks for personal loans) for cash advances to further ease cash-flow issues or financial strain.

It could be to help pay off credit card bills as the interest rates for late payments can be astronomical, or perhaps the personal loan taken will help to take care of the unexpected expenses at home such as medical bills or a broken air-conditioner.

However, taking on additional debt can be a risky affair.

But we do what we need to do, and the least we could do is to be responsible and do our due diligence so that we can make the best decision available.

So don't go running to a bank to hurriedly fill out a personal loan application before being 100 per cent sure that's what you REALLY need.

5 things you should never use a personal loan for

Technically, a personal loan can be used for almost anything. But just because the interest rate is in your favour, that doesn't mean you should recklessly take out a personal loan to fund your hedonistic desires.

Here are five things you should never use a personal loan for, and the reasons why:

1. A "want" that you can save for

Impatient to go on your two-month-long Europe vacation now that VTLs have opened, but you haven't saved up sufficiently for it? 

Nuh-uh, a personal loan isn't the answer.

It's never prudent to take on debt to satisfy your "wants". Instead, exercise self-discipline and set aside money to fund your trip. You could also consider getting a savings account with a higher interest rate to speed things up.

Just imagine, you take out a $20,000 personal loan, splurge on flights and spend like a king overseas. You return from your glorious holiday, now sadly saddled with debt that you didn't need to incur.

The same goes for other "wants" that you can save up for, such as that dream home theatre system or designer bag.

2. Investment with poor ROI

Not all investments are bad, but as there's always risk involved (you could lose your entire investment or more), a savvy investor won't pump in money that they cannot afford to lose.

Especially with the current stock market situation, it's tough to liquidate some of those assets for urgent cash flow without suffering a loss.

Even if your investment is stable and does okay, its growth might be lower than the interest rate of your personal loan - so there's a poor/negative return on investment (ROI), which doesn't make financial sense.

3. To finance a lifestyle beyond your means

It's one thing to keep up professional appearances for work, and another to continue splashing out on your extravagant lifestyle for the 'Gram or to avoid "losing out".

If you can't afford it anymore, stop spending on high-end restaurant meals (delivery now, of course), downgrade your ride, put a stop to your branded goods collection, and maybe it's time to take a hiatus from that country club.

There's simply no point looking rich while behind that veneer you're spiralling into debt and crying inside.

ALSO READ: Why you should never take a personal loan for home renovations

4. It's a planned major expense (like a wedding)

You've planned out the whole thing: Fancy engagement ring, overseas proposal, lavish garden-themed wedding, executive condominium and even your future children's education.

Unfortunately, everything's in your head, because you got distracted from saving along the way (new limited-edition shoes! Needed to zhng your car!).

You still have enough for the engagement ring, but for now, a local proposal's the only option.

At the rate you're saving, maybe a simple wedding with a dinner banquet in a restaurant would be possible, and let's just consider a four-room HDB flat in a non-mature estate for now.

Expenses for a wedding can be on the high side, so careful financial planning is key. Only spend within your means, and save as much as you can in preparation for it. Open a joint account with your life partner-to-be, set up savings goals, get an endowment plan, and so on.

It's also a well-known fact that one of the top things couples argue about is money.

And a haphazard decision to get a personal loan for a blowout wedding may impress guests for a few hours, but it might cause strain on your marriage (and finances) over time.

5. If there are better alternatives available

Maybe you want to take out a personal loan to buy a car, renovate your new home, fund your education, start a business, pay for your mortgage, or pay off as many debts as possible.

You don't need a personal loan for those things. There are other loans available that are better tailored to suit these specific needs, at more competitive interest rates.

For example, there are car loans, home loans, renovation loans and education loans available.

If you want to start a business, you can look out for government business grants in addition to financing options and mentorship programmes from government agencies such as SPRING Singapore. 

If you're in a lot of debt, sometimes a personal loan may not be the best option. Check out debt consolidation plans instead. 

The best personal loan to get: One you can pay back comfortably

First, you'll need to carefully consider the type of personal loan to get.

There are two types of personal loans - term and revolving. 

If 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 early full repayment, there will likely be a penalty.

If you are confident that you can repay the loan ASAP, but you just need quick cash to bridge a short-term gap, a revolving personal loan might just do the trick.

The interest rate can be a high 20 per cent p.a., but you won't be penalised for early full repayment. So the total interest you pay could be much lower than that of the term personal loan.

ALSO READ: Your monthly interest payments are set to spike in 2022 — here's what you need to know

Here's a quick summary of the differences between a term and a revolving personal loan:

Next, consider how much you can afford/need to borrow and your loan tenure.

There's no point in taking out the maximum personal loan (i.e. four times your salary) you can get when you don't need so much. Remember, you'll need to pay the interest as well - and that dollar value goes up with the amount you borrow.

Calculate how much you actually need to borrow, and how long is realistically comfortable for you to complete the loan repayments.

There's also no point dragging the loan tenure for five years (and accruing more interest) when you can easily pay off the loan in two years or less.

Here's an example:

Mr Lim earns $4,000 a month and wants to borrow $20,000.

If he takes a term personal loan @ eight per cent p.a. EIR:

Finally, what are you taking out the personal loan for? Can it wait? If it's just a want and not a need, do rethink your decision.

Check out the MoneySmart personal loan calculator and the latest bank personal loan interest rates here.

A personal loan may not be for everyone

Remember, taking on debt in the form of a personal loan has to be a carefully thought-out decision, with all the calculations done.

In troubled times, you should use it only when you absolutely NEED to, on important and urgent things.

You should also consider your financial situation. Are you earning a steady income, or do you see fluctuations each month?

That makes it difficult to estimate your monthly repayments and how much debt you can afford.

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.

This article was first published in MoneySmart.