Perhaps your friends and family are advising you against taking a personal loan, as they've heard cautionary tales and horror stories about defaulted loans and snowballing interest rates.
While there are definitely some things to be aware of before applying for a personal loan, a lot of the catastrophising and myths surrounding loans only cause unnecessary anxiety.
Here are a few myths about personal loans that need to be dispelled along with some facts about them you do need to consider before you apply for one.
Myth #1: Applying for a personal loan is bad for your financial health
Yes, applying for a loan that you're not realistically able to pay back is a recipe for disaster.
However, most people do not have enough cash on hand to make large, big-ticket payments for homes, cars or education fees. In fact, for most Singaporeans, it's highly unlikely you'll get by without at least one or two loans during your adulthood.
While applying for a personal loan in itself will not hurt your financial standing, being unable to make timely loan repayments or worse, defaulting on your loan will negatively impact your credit score.
However, if you are disciplined about making your loan repayments on time every month, over time, you can build a robust and healthy credit history. With a better credit score, you stand a better chance of getting approved for future loans and credit cards at a lower interest rate.
Personal loans can also be an effective tool for debt consolidation. For example, credit card debt can easily snowball and become difficult to manage as interest rates are generally much higher than they are for loans.
To get a handle on your credit card debt, you may consider applying for a personal loan to refinance your credit card debt, and replace your credit card debt with your personal loan debt which will be much more manageable since it has a lower interest rate.
See more: Cash in the time of COVID-19: Should you get a personal loan?
Myth #2: You can't get a loan without a fixed salary
Whether you're a freelancer or business owner without a steady income, or you're currently unemployed, there are many ways you can still apply for a loan without a fixed salary.
If you are a business owner, you need to be diligent about recording payments to your company. If you're a freelancer, make sure to be extra organised with your invoices. These will be used as proof of income when applying for a loan so that banks trust you to make regular repayments.
While it's not recommended to take a loan if you're currently unemployed, it's still possible. For example, through someone co-signing your loan.
A co-signee would be responsible for making repayments in the event that you can't afford to. This could be anyone with a good credit score, from a parent to a close friend. However, it's important to understand that should you fail to make payments on your loan, this person would also be liable and their credit score will be affected too.
Myth #3: You need collateral to be approved for a personal loan
Loans in Singapore can either be unsecured or secured.
Secured loans are loans with collateral or assets to back the loan, in the event the borrower defaults on it. These assets will be seized in the event the borrower cannot make repayments.
However, most Singaporeans take unsecured loans which are not backed by any collateral. The only consequence of defaulting on a loan that is unsecured is that your credit score will be negatively affected.
Damaging your credit score may seem like an easy way to get off on not repaying a loan, but it's so important to understand the severe consequences a tarnished credit score can have on your future.
It's also important to note that unsecured loans will have higher interest rates as compared with secured loans. If you fail to repay, you may also face legal action and other consequences because there will be no one else to foot the repayments.
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What to look out for when applying for a personal loan
With a few of those myths about personal loans out of the way, what are some actual facts about personal loans you'll want to keep in mind when applying for one?
Here are a few top considerations to pay attention to before choosing a personal loan.
You'll want to pay attention to two types of interest rates for a personal loan you're considering - the nominal rate and the effective interest rate.
The effective interest rate takes into account compounding interest accumulated over time, annual fees and is recalculated every month based on the remaining amount of your loan.
Meanwhile, the nominal or annual flat rate is the fixed percentage of the total amount which the bank will charge you until you pay the total sum back. For instance, if you borrow S$6000 and are charged a flat rate of 4% for one year, 4% is your nominal rate.
Other fees and charges
While you may be tempted to opt for loans with 0% interest rates, there's no such thing as a free meal with a personal loan.
Instead of interest rates, you'll be probably be charged with processing or origination fees which are a 2-3% fee which is usually deducted from the total amount of your loan as an extra charge.
Early redemption fees are also something to keep an eye out for when you want to pay off your loan earlier than the tenure duration.
The goal is to repay your debt as quickly as possible, so you'll want to make bigger payments on the months you can afford to. This may be possible with flexi loans which allow you to pay more than your nominal rate every month.
However, do note that most loans in Singapore have a minimum tenure of 12 months. This is to ensure that banks who lend you money make enough of a profit with the interest accrued from the loan.
Personal loan vs specific loan
There are major differences between taking a personal loan vs a home loan, student loan or car loan which you'll want to consider.
Depending on what you're borrowing the money for, you might be able to apply for a loan with lower interest rates if you opt for a home loan, car loan or student loan.
However, these specific loans will restrict you from spending it for other purposes. So if you take a home loan, for example, you'll be restricted from using the amount borrowed for anything other than your mortgage.
Hence, if you need more flexibility with how you spend the amount you borrow, a personal loan may still be best for you.
When applying for a loan, you may be able to get a lower interest rate if you apply with a higher credit score.
If you can afford to wait a few months or years before applying for a loan in order to improve your credit score first, this is definitely worth considering. You might save more in the long run in your repayment amount when applying for a loan with a better credit score.
See more: Maintain or better yet, improve your credit score? Here's how.
What happens if I default on a personal loan?
In cases where the bank suspects you have the money but simply do not want to pay back the amount borrowed, they may even take legal action against you.
This also happens when they suspect you are planning on leaving the country indefinitely without repaying the loan.
Your employment prospects could suffer
Defaulting on a loan could leave severe consequences on your credit report. Employers may perform a credit check to screen you as a safe candidate to hire.
This is especially true for potential jobs in the banking and financial sector which require you to handle large amounts of money or where you would have a higher level of access to large funds.
If your credit score does not meet their requirements, you may be rejected for the role.
Your credit rating will be severely affected
When you default on a loan and make no efforts to repay this debt, the bank eventually writes the loan amount off as a loss. While this might feel like the borrower is getting off scot-free, there are severe consequences for not repaying a loan.
Making no efforts to repay the loan and simply disappearing will leave a permanent record on your credit report of the default.
If you can't afford to pay back a loan, you should always seek the assistance of a credit counselling service. Once you work out a repayment plan with their help, the default or partial default may be removed from your report after three years.
Your funds and money may be seized
Depending on which bank you're borrowing from, certain banks may have terms in their loans which allow them to seize funds from your accounts within the same bank to pay off your debt.
Be sure to check the terms of your loan carefully. You don't want to wake up one day to discover your savings have been used up for a loan without your knowledge.
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