Borrowing money is a common thing, but before you take a personal loan, it is very important to know the consequences you have to face if you fail to repay the loan. Some debts are worth to go for because you will get the value in return at the end for which you paid such as Business Loan, Home Loan, Mortgage Loan, Education Loan and Car Loan, but many others can create a big financial trouble for you. If the loan which you are planning to take, cannot be justified in terms of purpose, requirement, interest, and repayments, such loans are always a bad loan. Not all the loans are bad debt. A bad debt is one which is not a worth of its value and it also drains your money. Bad debts can also be defined on the basis of ‘the loans which has no real prospect’ going for. The interest rates are also high which results to high EMIs and hence difficult to afford.
Example of Bad Debts:
Borrowing money for the lavish party or a shopping.
Borrowing money to go for an unaffordable trip.
Loan for a purchasing expensive equipment and gadgets.
How to avoid a Bad Debt?
In order to prevent a personal loan from turning into a bad debt one must think and analyze the below things even before applying for the loan:
- Is that loan for which you are taking is really useful to you? Are there no other choices, except that loan?
- Would you be able to pay the EMIs throughout the duration of the loan without disturbing your budget?
- Have you compared the interest rate for your personal loan with different financial institutions? If yes, is the interest rate offered by your lender same or lower than the other lenders proving the same loan.
- Will you be able to repay the loan amount easily without any difficulty?
If the answer to any of these questions is NO then your debt is absolutely a bad debt and you need to avoid it!
Bad Debts can lead to:
- Waste of Your Money: A Bad Debt always has a high-interest rate. Therefore, you need to pay a big amount from your monthly earning in EMI. This will gradually and slowly drain your money. Which is not at all worth.
- Seizing of Collateral: In case if you are not able to repay the loan as it was a bad debt and had high-interest value, then the collateral which you have given against the loan will be seized by the lender or the ownership of the collateral will go to the lender.
- Legal Actions: In case if one is unable to repay the loan in time, then, in that case, legal actions can be taken by the lender against you to recover the outstanding loan amount.
- Bankruptcy: This can happen to anyone at the time of not repaying a loan. In this case, all the property and money of the borrower will be taken over by the lender. This only happens when the collateral is not given against the loan or when the value of the collateral offered is not of the same value as that of the loan amount.
Precautionary Ways to Stop Personal Loan from Becoming a Bad Debt:
If you have already become a victim of bad debt and if you are finding it difficult to repay the loan or even paying the EMIs there are a few steps which you can follow to get out of it-
- Monetise Assets:
For beginners, personal loans come in different terms, types, and sources. Unsecured personal loans generally carry a higher interest rate bearing due to their inherent risk. This form of loan should be the last alternative for anyone in need of funds.
If you have a personal loan and own assets such as home, gold jewelry, car, mutual funds, shares, life insurance policies, RBI Bonds, bank fixed deposits, National Savings Certificate and debentures it is recommended to monetise them to get rid of this highly risky funding option. In case of loan against assets, while the banks have the assurance of an underlying security, you enjoy a relatively cheaper credit. You can even liquidate few assets and use the returns from the same to complete loan payments.
- Go for Refinance or a Debt Consolidation Loan:
Another option you can opt for is Refinance or debt consolidation. If you have multiple loans to pay off and you find it difficult to repay the EMIs then you should go for a debt consolidation. Here all the components of your debt portfolio are combined by one lender and you have to pay just one monthly installment which is usually relatively lower than all your combined payments over a longer tenure. Refinance is nothing but taking a new loan with low-interest rate either from the same or even from the different bank to pay off the outstanding amount of your previous loan. In this way, you will end up with the high-interest loan and you have to pay less EMI for your new loan.
- Talk to Your Lender:
If you find the EMIs too high and you can’t afford to pay in that case you can talk to your lender about restructuring the loan to smaller EMIs and greater tenure. If you do so, you will be able to repay the loan easily, this will cost you more as by increasing the tenure and reducing the EMI you will be paying more on the interest. But this is a better option against not paying the EMIs and continuously paying penalties as this affects your CIBIL Report and legal actions can also be taken against you.
- Ask Your Lender for Settlement:
This is considered the best option when you are in a debt trap and are unable to repay. For this, you need to request to your lenders and make them agree for accepting an amount less than the total outstanding amount including principal and interest but more than the principal amount. If the bank agrees to this you can pay it off easily and get relaxed from this burden. Loan settlement can impact your credit score negatively for a while.
- Converting an unsecured personal loan to secure:
Have a word with the lender to find if your unsecured personal loan can be turned into a secured one (against vehicles, house, if they are unencumbered) and restructure it for a lower monthly payment to reduce the risk of bad debt. You must ensure that the tenure and interest rate of the secured loan is a favorable option making sense.
- Soft loan:
Take a soft loan from friends or family to pay for the personal loan, in case you are unable to secure urgent cash for the EMIs.
- Increase repayments with a rise in income:
One simple way to repay your loans faster is to bump up the EMI with every rise in your income. Don’t underestimate the impact of this modest increase. Even a smaller increase in EMI can save you a lot in interest. Thus, whenever there is additional money flowing in, priority should be given to the prepayment of loans. If you have multiple loans running at the same time, make sure that you direct the additional payments towards the costlier loans.
Personal loans must be considered only when you don’t have any backup of assets and have a visibility on your cash inflows and ability to repay. It should be used only as a short-term measure to tide over a situation. Personal loans are always cheaper than credit cards because they have low-interest rates compared to credit cards. You must compare the actual money outflow in a total duration of the loan based on EMI plus other charges. Then to get the best deal, you must negotiate with the banks with your credit history. One should beware of the flat interest rates. As in many cases, it may appear cheaper to borrow, but will turn out to be a much expensive proposition.
Lastly, do not feel shy to cry out for help. If you are unable to figure out a way out of your debt hole, approach a debt counseling center, which offers an advice, some charge a fee for their services and some not. These are actively engaged in helping borrowers facing problems with their loan repayment by offering credible advice.