How to Identify a Good Loan and a Bad Loan?
Last Updated : March 31, 2021, 10:56 a.m.
A loan makes things possible when they look very hard to achieve at the face of ‘NO’ to very little savings. From a consumer durable to a home, everything is getting bought with a loan these days. Numerous banks and non-banking finance companies (NBFCs) have lined up lucrative credit deals to woo you. Some give attractive interest rates, some provide greater loan amounts and some waive off the processing fee. These are all tactics to get customers on board. But as a customer, you should know whether the loan you are about to take will prove useful or not. A lot of us don’t pay attention to this and end up incurring costs without much avail. So, as a borrower, you should identify which is a good loan and which is not so. We can help you in identifying the same in this post. Let’s get started!
Points You Should Consider to Distinguish Between Good and Bad Loans
Identifying good and bad loans will require understanding critical factors such as the impact of the loan on your income, budget, and even your credit score. Also, consider value additions such as income tax benefits when distinguishing between the two. Let’s check out all such factors below.
Check the Impact of Loan Interest Rate on Your Income and Budget
A lender might promote the loan offer giving punchy headlines like attractive interest rates. But are they really attractive? Go and find out the same online. Don’t simply go by the percent you see in an interest rate, check its impact on your income and budget using the EMI calculator. How much will be the monthly obligation i.e. Equated Monthly Installment (EMI)?
You could get a loan even when the proposed loan EMI and your existing obligations add up 50-60% of your net monthly income. But you would be better off taking a loan when existing obligations are much lesser so that you can make up for any sudden rise in your expenses. While the EMI consideration is of utmost importance, taking eyes off from the overall interest outgo will make you curse for the loan you service.
Do check how much interest you will pay to the lender on the interest rate it levies on your loan. Sometimes through a small bunch of EMIs, you end up paying a massive amount to the bank or NBFC that you may not have thought of. In case you see a massive interest amount, look for a better interest rate deal.
Check Whether the Loan Does Any Value Addition for You
The loan you take should not only help meet your instant needs but also return you something, be it in the form of income tax benefits or value appreciation. In case you use a loan to buy something whose value drops down significantly over time, there’s no point having it.
Check Which Loan Can Raise Your Credit Score Quickly
Every loan has an impact on your credit score and credit history. But there may be a loan or two that can raise your credit score quicker than others. Look whether such loans are suited to meet your needs. If so, apply for them. At the same time, if you take a long-term loan, you could have a long credit history and a good one provided you pay your dues on time. A good credit score helps you in more ways than one.
Can We Now Figure Out a List of Good and Bad Loans?
As we are clear on the points that can help us categorize good and bad loans, we can just look at loans that conform to these principles and the ones that don’t. Let’s start with good loans first.
Home Loan – It is a good loan as it helps you buy an asset that can generate regular income for you if you put it on rent. Also when you sell it to someone, you could get a considerable value as real estate prices will most likely rise over time. What’s more, you can avail of tax benefits on a home loan. While principal repayments offer a maximum tax savings of INR 1.5 lakh, the interest payments allow tax savings upto INR 2 lakh in a financial year. And when you put it on rent, there will be no limit on tax deductions on interest payments.
Even the monthly obligations can be much lower in a home loan compared to other loans as the interest rate here is 7%-8% per annum. It might drop even further given the weak economic conditions that continue to persist due to COVID-19. Since this loan is taken for a long time i.e. 20-30 years, your repayment cycle will be quite long. The timely payment of the EMIs for long will only help you with a good credit score.
Personal Loan at a Lower Rate of Interest – A personal loan is a multi-purpose loan as you can use it for numerous purposes such as marriage, education, travel, medical emergency, etc. The seamless approval and easy documentation make it a nice experience for you. All you need to do is compare personal loan interest rates online and choose the one that is lower and suits your budget.
Secured Credit Card – Credit cards have made things easy for people by offering comfort and privileges to them. You can book travel tickets, reserve a dining table at restaurants, or even buy movie tickets using these cards. Spending on credit cards offers you reward points, cashback and even discount, thereby enriching your shopping experience. But many fall into the lure of these benefits so much that their bill goes out of their reach and they struggle to pay on time. By letting the situation deteriorate further, they finally succumb and default. What happens then is a poor credit score that they have to contend with.
In case this is your story too, you can get the script better this time around by opting for a secured credit card. This type of credit card is offered against fixed deposits. You will be offered a credit limit at about 80%-90% of the fixed deposit value. You may ask, will your fixed deposit get blocked with this? No, it will not! Instead, you will keep earning on it. Not only secured credit cards come with no fee, they also help improve your credit score quicker than others. Just pay the bill on time and keep building a good credit history for you.
Loans That You Should Avoid Taking
The heading suggests that the loans to be discussed from here are not good and one should avoid taking them. These loans don’t add much value to you. They might help you achieve a good credit score if you pay dues on time. Other than that, there is not much to write home about. Let’s read why we say so.
Buying iPhones and Other Smartphones via Loans or Credit Cards
We all live in a world where we tend to follow our peers so that we are not out of focus. To maintain social esteem and stay at par with peers, a lot of us buy costly mobile phones such as iPhones using loans or credit cards. There’s no harm in having such accessories if you are using your savings to purchase those. The reason why it does not make sense using loans or credit cards is that the value of these phones falls sharply and that too very quickly. It won’t be a surprise if the prices of phones drop by around 30%-40% or more in just 1 year. So the money you pay via loans or credit cards to own these phones will be much more than the money you could get on selling it.
Taking a Car Loan When You Don’t Need a 4-wheeler
Given the high prices of cars, you will need to take a loan to buy the same. But like smartphones, a car is also a fixed asset whose prices fall sharply over time. In fact, the moment the car leaves the showroom and hits the road, the price of the car starts falling. And over 2-3 years of the acquisition, the price of the car can be half the amount that it may have at the time of purchase. So, if you don’t need a car, avoid buying it on a loan. The loan payment will be much more than the amount you could get on selling the car.
Taking a Loan to Invest
The lure of investing in stocks and making big bucks from the same can make you feel excited. But don’t take a loan to invest in such avenues. The reason is pretty simple. Stocks can offer big returns but can be a risky affair at the same time. The stocks you buy may crash due to sustained negative market sentiments, causing a barrage of losses for you to deal with. And if you are thinking of taking a loan to invest in debt instruments, cancel this idea too. The returns from debt instruments such as bonds and debentures are going to be much lesser than the interest you will pay towards a loan. If you want to invest whether in equity or debt instruments, use your savings and not take a loan for the same.
Conclusion
You must have known by now the difference between a good loan and a bad loan. Take loan actions considering the tips advised in this post so that you don’t lose out on benefits while also keeping your cost in check.
