Is it ever a Good Idea to take a Personal Loan?

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Over the past week, I received 7 text messages, 2 calls and came across several advertisements which looked like these.

What were they trying to get me to do? Take a Loan.

Loans are commonly disbursed from Banks or Financing companies. I would like you to understand that there are two categories of LOANS.

  1. SECURED LOANS.According to Investopedia.com, Secured loans are a debt backed or secured by collateral to reduce the risk associated with lending. If the borrower on a loan defaults on repayment, the bank seizes the collateral, sells it, and uses the proceeds to pay back the debt. Some examples are loans for property and motor vehicles.
  2. UNSECURED LOANS.The Bank assesses the ability of the borrower to repay the debt through means like credit score, earned income, banking relationship, and the bank assumes a higher risk to loan you the money because you have no collateral and you are not required to pledge any specific assets as security for the loan.  Some examples are Education loan, personal loans and credit cards.

This is largely why borrowing interest rates of the 2 are relatively different ~2% VS ~6-25%, Secured VS Unsecured Loans.

With unsecured borrowing showing such interest rates, it may prove to be an obvious option for one to cast aside – why would anyone even consider such an option? However, not all personal loans are that in your face. With clever marketing, some individuals may be assuming one even without their own awareness or complete understanding of the product.

I am sure you would have come across banks offering personal loans which reflect 2 interest rates, for example with one a 0% interest, at a fee payable e.g. (EIR 14.82%)
The 0% here is known as the advertised rate, which is the interest the bank charges you on the sum you borrow.
The EIR or Effective Interest Rate reflects the true cost of borrowing to the consumer. It is usually higher than the advertised rate considering that it includes service fees charged upfront for processing and approving your loan application.

Without understanding these, it may sound like a very attractive deal to get instant cash/delay upfront payments at a “simple” processing fee.
Always be mindful of the true cost of borrowing and look beyond the marketing to gauge its suitability.

Having said all this, there may be a time and place for such solutions.

Some examples are:
– Consolidating credit card debt – if you had a debt snowballing at 25% p.a., consolidating it into a personal loan at a lower interest rate may sound like a feasible idea.
– Paying for Emergencies – emergencies or accidents are occurrences that come unexpectedly, like a major medical bill or a family member in sudden financial need. sometimes these require amounts that some of us may not have prepared for. However, the aim here is to gain access to the funds, but also as quickly as possible, pay off the loan so as not to incur too much interest.

On the other hand, if you’re considering using these loans for purpose like paying for your dream wedding or a grand vacation? Please don’t. Always plan and save in advance and commit to things that you can afford.

What are some reasons that would justify taking a loan? Leave a comment below – I would love to hear your thoughts.

The views expressed here are solely those of the author in his private capacity and not necessarily to the author’s employer, organization, committee or other group or individual.

References:

https://blog.moneysmart.sg/opinion/personal-loans-emergencies-advertising-tips/

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About Me

Hi, my name is
Joshua Hoong
I’m a Chartered Financial Consultant (ChFC) at ACTS Advisory Group, IPP Financial Advisers specialising in comprehensive Retirement Planning, as well as a Million Dollar Round Table (MDRT) member.

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