The increasing cost of living has made it that much more taxing on our cash flow these days. Unlike before, it is now less of a taboo in Singapore to apply for a personal loan just to tide over temporary cash flow problems or fund a passion project.

Not sure if a personal loan is for you? Here is a look at what such a loan is good for and the five things you must look out for before applying for one.

What is a personal loan and how to use one to your benefit

In Singapore, a personal loan is a type of unsecured loan that individuals can apply for to meet their personal financial needs. No collateral is required but the loan sum is smaller, usually up to four times the sum of your monthly income. The loan tenure is also shorter, ranging between six to 60 months.

The best personal loans in Singapore are great options if you have sudden large expenses like an unexpected car repair, medical bill or a significant event, like a wedding, that need a large sum of money to tide over.

It is also common to use such a credit facility for debt consolidation whereby the loan is used to pay for multiple high-interest debts and consolidate them into a single monthly payment with a potentially lower interest rate.

If you are starting a small business, a personal loan also provides the needed capital to supplement business-related expenses can be a viable option. Unlike taking out a business loan which requires more stringent processes, a personal loan may offer a more straightforward solution.

Want to further your education but lack the funds? Personal loans can be used to finance education expenses, including tuition fees, books, supplies or even professional development courses.

Five factors to look out for when applying for a personal loan

When applying for a personal loan for the first time in Singapore, there are several important factors to consider because they can affect your affordability. Here are some key points to keep in mind:

Factor #1: What is the interest rate?

Lower interest rates mean you will pay less over the loan term. Always compare rates and look for a lender that can offer competitive rates with reasonable terms. In your search, you may come across two terms - Applied Rate (AR) and Effective Interest Rate (EIR).

AR is the typical advertised rate which refers to the actual interest rate that is applied to your loan. It is the interest rate that the lender uses to calculate the interest charges on your loan amount and does not take into account the fact that each repayment results in the reduction in the principal amount.

What you must really take into consideration is the EIR. This is because EIR reflects the true cost of applying for the personal loan in Singapore.

It represents the actual interest rate you will be paying on your loan, taking into account both the nominal interest rate and any applicable fees or charges associated with the loan.

Factor #2: How long is the loan tenure?

The logic is simple, the shorter the loan tenure, the higher the monthly payments. On the flip side, the longer you stretch your loan tenure the lower your monthly payments.

You need to weigh your affordability even if you prefer to pay off the entire loan sum within the shortest period of time.

Most banks in Singapore will offer a minimum tenure of 12 months for a personal loan, depending on the sum you loan, try to negotiate for a repayment schedule that is most comfortable for your monthly cash flow.

Factor #3: What are the fees, charges and penalties?

Get clear about the fees associated with the personal loan before signing on the dotted line. Lenders can slap on a myriad of fees such as processing fees, late payment fees and admin charges that can increase your debt if you are not careful.

While you are at it, do a double take on any flexible repayment terms such as the ability to make additional payments or early repayment without penalties.

Having the flexibility to manage your loan repayments according to your financial situation can be beneficial should you receive an influx of cash and prefer to pay off your loan ahead of schedule.

Factor #4: What is my credit score?

Your credit history can affect your eligibility to apply for the best personal loans in Singapore.

Unless you intend to take out a loan from a licensed moneylender, banks in Singapore will run a check with the Credit Bureau to evaluate your creditworthiness and ascertain if you meet their prerequisites to receive a loan.

A good credit score increases your chances of approval and helps you negotiate better loan terms. As a rule of thumb, scores that are closer to 2,000 indicates you are in a healthy financial position. If your credit score is around 1,000, banks may perceive you as a likely candidate to default a loan and reject your loan application as a result.

Do worry if you do not have a good credit score, you can always improve your credit score before submitting a loan application.

Factor #5: Am I borrowing within the total debt servicing ratio (TDSR) limit?

TDSR was implemented by the Monetary Authority of Singapore (MAS) in 2013 to regulate responsible borrowing. Under the TDSR framework, you can use only up to 55 per cent of your gross monthly income to service your debt obligations.Any loans that you apply beyond this limit will automatically be rejected.

For example, if you make $5,000 a month, your maximum monthly debt repayment limit is $2,750 ($5,000 x 55 per cent). If you have existing loan repayments such as car loan, mortgage or credit cards that already amount to $2,750 per month, you will not be eligible to apply for additional personal loan in Singapore.

Conclusion

It is important to note that while personal loans can be helpful, responsible borrowing is crucial to ensure you do not get trapped with insurmountable debts.

Before taking out a personal loan, consider your ability to repay it on time, review the terms and conditions, and assess the impact on your overall financial situation. You should compare loan offers, interest rates, and fees from different lenders to be sure that you are getting the best possible deal.

ALSO READ: 5 best personal loans in Singapore with lowest interest rates (May 2023)

This article was first published in ValueChampion.