What Types of Loans Should You Avoid?

Last Updated : Oct. 22, 2020, 5:32 p.m.

The lack of credit awareness makes many go for a loan that does not help them much over time. Such loans may help meet their needs but pile on the cost for them in return. As a result, many go on to either default on loan payments or end up paying much more to banks or non-banking finance companies (NBFCs). Any of these is not advisable for you. A default will cause disrepute to your credit profile and make you face unwarranted legal notices (in case of unsecured loans). Whereas excessive payments to the lender will reduce your savings drastically.

But the point is to know the loans that force individuals to commit such grave credit errors. A lot of us find it hard to figure out the same. If you are one of those, we can help you identify loans that you could avoid for your own good. All you need to do is read further.

So Which Loans Should You Avoid?

To say whether a loan is good or bad, one should study its cost in proportion to the benefits it provides. If the benefit feels negligible in proportion to the cost involved, you should discard that loan. Keeping that in mind, we advise you to avoid a loan to invest in shares or any other financial instrument, a car loan (If a car is not your need), any loan at a much higher interest rate, and even the revolving credit card debt. All these will only mount worries for you! Let’s check how.

Loan to Invest in Shares or Any Other Financial Instrument

The ability to multiply the invested capital exponentially over time makes many invest in shares. But there is a downside too. Shares are very sensitive to social, political and economic developments that take place locally and internationally. In case developments are not good for the market, shares can fall rapidly too. And, if you take a loan to invest in shares, you will only feel bad if such a thing happens. On the other hand, fixed deposits and debt mutual funds can’t offer you returns more than the interest you will pay on a loan. So, if you want to invest in shares or other financial instruments, use your savings only.

Avoid a Car Loan If You Don’t Need the 4-Wheeler

Having a car does add to your social esteem. But what about the cost of such an acquisition? It’s not only about the purchase price of a car but even the loan you might take to fulfill this dream. You might get it at a reasonable interest rate of 8-12% that prevails these days. But the point is that the value of cars falls substantially over time. So, if you look to sell the car after some years, you may not get the value you expect because of the sharp depreciation that takes effect in cars. The interest payable on a car loan can exceed the money you might get on selling the 4-wheeler. So, you won’t feel good buying a car on a loan if it is not your need.

Loans Taken at a Much Higher Rate of Interest

Personal loans are chosen by many to fulfill their various needs such as marriage, travel, education, medical emergency, etc. Since a personal loan does not require any security or collateral, its interest rate can be higher than that of secured loans. But a good credit score, healthy income, impressive job profile can lead to rates lower than usual. If you have these, you should negotiate instead of thinking that a high personal loan interest rate is normal. Such thinking will only increase your debt obligations, which could reduce otherwise. You can understand it better with an example. Take a look.

Example – Akanksha and Vijaya have a good credit score of more than 800 and want a personal loan of INR 8 lakh each for 5 years. Both earn the same and work in a top organization. While Akanksha negotiated and got an interest rate of 12.50%, Vijaya accepted the deal at 18%. Let’s find out how Vijaya will end up paying much more than Akanksha.

Vijaya, by accepting the deal at 18%, will end up paying INR 1,38,984 (4,18,885-2,79,901) more than Akanksha despite the former having all that’s required for getting a lower rate.

So, check the interest rate of different lenders and select the one that offers the lowest rate. The below table contains the interest rate of top lenders. Check, compare and choose.

Fixed Rate Home Loans

Lenders offer home loans predominantly on a floating interest rate, which means the rate will change based on the changes in market rates. The floating home loan interest rate ranges from 7-8.50% per annum. But there is a fixed rate home loan where the interest rate does not change despite changes in the market rate. Some apply for the same considering this point. But they end up cursing themselves! It’s because the rate of interest in a fixed rate home loan is around 2-4% higher than a floating rate loan. As the loan goes on for about 20-30 years, that 2-4% difference leads to a massive difference in the eventual loan outgo. Let’s consider an example and see how it happens.

Example – Prakash and Shyam opt for a home loan of INR 50 lakh each for 20 years. But while Prakash chooses a floating rate loan of 7.85%, Shyam goes for a fixed rate of 10.50%. Let’s see the repayment scenario of both.

Shyam will pay around INR 19,55,012 (69,80,559-49,25,547) more than Prakash by choosing a fixed rate. Yes, the interest outgo of Prakash, who takes a floating rate home loan, will change from what’s shown above. But that will still be way below that of Shyam.

Revolving Credit Card Debt Mounts Cost Way More Than Your Estimation

Credit cards, if handled well, can help you shop for movies, dining, accessories and others without any hassle. But if you show indiscipline and shop more than you could pay, problems will greet you! Further, if you choose the path of partial credit card payment, you will only compound your worries. Credit card companies allow you to pay a minimum due, which accounts for around 5% of the outstanding balance in a billing cycle, to prevent a late payment fee.

But paying the minimum due or more than the same but below the total due will lead to interest on the unpaid balance at about 30-45% per annum. You can thus imagine how painful it could be for you to revolve your credit card debt at such a high rate. So, use your credit card with utmost discretion and pay the credit card bill in full on or before the due date. This way, you will avoid interest on credit card transactions.