It is now a viable option to take a loan for important personal expenses like renovating your house, taking a family vacation when everyone’s vacations are around the same time. Being a salaried or fixed income professional can make cash flow a hurdle when it comes to making plans like these and many people who know they will be able to pay for expenses that they need to make urgently, over a predetermined period of time.
Indeed, financial responsibility is about prioritizing your expenses and utilizing your funds to the best possible extent. It is not always necessary to have to the funds for the investments that you need to make, if you know you have a steady source of income and can afford to take a personal loan and pay it back.
However, this is an oversimplification. Often times, institutions that provide personal loans will only disburse them at an exorbitant interest rates that may seem like they are low but thanks to a variety of in built charges that may not be apparent when you avail the loan, you can end up paying back an amount that is much higher than what you may have initially accounted for.
Suppose the lender – let’s say a bank offers you a personal loan of Rs 300,000 at a flat rate of 15 per cent for three years. You may be led to believe that interest rates will rise further and agree to opt for a flat interest rate. Since you will be paying an equated monthly instalment of around Rs 12,000, the principle as well as interest should be reduce every month, but when you opt for a flat interest rate, it ends up being the most expensive option.
On the contrary, under the reducing balance method the principle gets reduced daily, monthly, quarterly or yearly. As, the principle amount gets reduced, the interest that you pay is on the reduced principle and therefore lower, as well. Hence, many financial advisors recommend opting for a floating interest rate.