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The biggest advantage of personal loans is that you can quickly get cold hard cash in your hands to use for any personal reasons.
Especially because it is so convenient to get, you need to be very disciplined to avoid over-relying on such easy access to cash. At the same time, when you do apply for a personal loan, you have to crunch your numbers – and ensure you can afford to repay the monthly instalments.
Ultimately, your financial well-being will boil down to how you use personal loans.
Personal Loans Are Unsecured – Making It Simpler To Obtain, Easier To Get Hooked On
Personal loans are generally easier to obtain because they are unsecured, and do not require any collaterals. Most personal loans also have a fixed term and interest rate. This streamlines the application process.
In fact, when you apply for a personal loan, for example the CIMB Personal Loan, new customers can simply submit their application using MyInfo and without the need to apply for a credit card or any other account. The entire application process can be completed online in just 10 minutes.
Personal loans are also disbursed in cash rather than paid directly to third parties. This is unlike other loans we may take, including home loans, reno loans and car loans. Making it even more attractive to those who urgently need cash.
Typically, banks will give you a personal loan up to a certain multiple of your monthly income. This balances both affordability of the personal loan and having access to a sufficiently large enough loan. In the case of the CIMB personal Loan, there is a generous credit line of up to 8x* of your monthly income.
While speed and simplicity can be advantageous, mismanaging personal loans can easily lead to unnecessary spending and excessive debt. Besides practising financial prudence, you should also understand how much your personal loan will end up costing you.
Looking at the CIMB Personal Loan (chart below), it provides transparency of interest rate based on loan amount and tenure, starting from 3.38%* p.a. (or an Effective Interest Rate from 6.32% p.a.). However, you can also see that the Effective Interest Rate (EIR) can rise to over 18%. Typically, shorter-term and lower personal loan amounts will charge higher interest rates.
Source (as at 15 November 2023): CIMB
Understanding the difference between the Advertised Interest Rate and the Effective Interest Rate (EIR) can also help you make better personal finance decisions.
For a start, you will realise that the EIR is always higher than the advertised interest rates. Let’s take a $10,000 personal loan as an example. You can use the CIMB Personal Loan calculator to get a clear and transparent understanding of how it will look like repaying a personal loan.
Source (as at 15 November 2023): CIMB Personal Loan Calculator
You will end up paying an interest rate of 3.38% p.a. This is derived by simply taking the total interest that you will pay by your loan tenure ($1,690 / 5 years = 3.38% p.a.).
Source (as at 15 November 2023): CIMB Personal Loan Calculator
However, since you will be paying both interest and principal components each month over the next 5 years, you aren’t actually benefitting from the entire $10,000 loan over the loan tenure.
This is why it will end up costing us an EIR of 6.32% p.a. as you can see on the CIMB Personal Loan Calculator. Hence, you should also compare the EIR which reflects the true cost of borrowing.
Using Personal Loans For The Right Reasons
When you take a personal loan, keeping up with your monthly loans and keeping track of payment dates will just add stressors in your life. If you do not manage your repayments and monthly cash flow well, you may find yourself trapped in a cycle of rising debt with increasing interest payments.
This is another reason you need to carefully consider if you are truly using a personal loan for the right reasons. Here are three instances when you may need a personal loan.
#1 When You Already Have Mounting Credit Card Debt
For those with credit card debt, you will find that interest rates are very high. Consolidating all your credit card debt under a single personal loan can alleviate some stress in dealing with so many financial institutions and payment deadlines.
Interest rates can also be more favourable, especially as financial institutions may also run promotional offers with attractive interest rates. Obviously, you should choose the one that charges you the lowest effective interest rate.
For those helping a loved one deal with money lenders or finance companies, you may be familiar with 20% interest per week rather than per year! You’re better off shifting your counterparty to a financial institution, via a personal loan.
Not only will you pay lower interest rates on your loan, but it will be much less stressful and you and your loved ones will be safer.
#2 When Business Owners Want To Keep Your Lights On
Under Armour’s Kevin Planks used his personal savings and credit card debt to start up his US$3 billion sportswear giant. Starbucks’ US$110 billion coffee empire started with three founders investing US$4,050 and borrowing US$5,000 from a bank.
Like me, you may be enamoured by such entrepreneurial fairy tales. However, we don’t hear of all the business failures – which probably number many more. We should be cautious in using personal loans for business ventures.
If you’re already running a business, a personal loan can be a quick and easy option when you’re in a tight spot. Not a great option, but at least an option that keeps the lights on. For many entrepreneurs, being able to make payroll, even in dire situations, shields employees from business stress – and enables them to continue working hard to keep the business afloat.
Of course, you should also consider other SME loan options. However, bear in mind that they may take slightly longer to disburse, and may require personal guarantees as well.
#3 When You Need To Draw Down Your Emergency Funds
You should have an emergency fund worth between 3 months’ and 12 months’ of your monthly expenses. Regardless of how much you’re actually setting aside, drawing down on this fund can mean that you’re in an especially vulnerable situation.
While you should carefully budget for your expenses, especially big-ticket expenses such as a wedding or a home renovation, it’s not entirely out of the question for costs to overrun. In these situations, you can fall back on your emergency funds.
If you don’t have a sufficient emergency fund, or any to begin with, you may find yourself and your loved ones in a financially precarious position. In such situations, any further requirement to draw on emergency funds in unexpected situations can lead to great stress.
A simple broken refrigerator or leaking water tank at home can send your personal finances in a tailspin – requiring you to borrow money. Taking up a personal loan can be a quick fix while you strengthen your personal financial situation.
More Options Is Never A Bad Thing – Unless We Make It A Bad Thing
Whenever we have editorial discussions at DollarsAndSense, we usually conclude that more options for consumers is never a bad thing. Similarly, personal loans offer consumers a valuable resource for managing your finances and overcoming unexpected expenses, especially in circumstances when you may need it the most.
However, taking a personal loan can be a double-edged sword, with potential harm to your financial well-being if used wrongly. To make the most of personal loans, it’s crucial to understand what you’re getting into – i.e. having to make regular repayments and forking out an interest payment for the benefit of taking the loan – and approach it with careful consideration.
If used for the right reasons, personal loans may be the lesser of two evils. Potentially reducing a more significant source of stress – even though you now have some stress to repay the personal loan.
Finally, when you’re seeking out personal loans, it makes sense to get the best out of the deal. Usually, there will be promotional interest rates – like the 3.38%*p.a. (EIR from 6.32% p.a.) interest that the CIMB Personal Loan charges – and there may also be sign-up perks – such as up to $2,000* cashback that the CIMB Personal Loan offers.
These help to reduce your overall costs, but should not be viewed as incentives to take larger or more personal loans.
*T&Cs apply. Refer to CIMB for more information.