Avoid “low-interest” Personal Loans, Unless Strapped For Cash

The ongoing pandemic has derailed normal life and, more importantly, impacted the personal finances of the common ”mwananchi”. Pay cuts, deferred salaries and loss of revenue for those in business have become common.

Banks and MFIs have launched special, low-interest personal loans and announced massive restructuring plans. Interest rates start at as low as 12.00 per cent for such loans. These are aptly called COVID-19 personal loans, as they are being offered for the specific purpose of helping people tide over a temporary liquidity crunch.

But first, not everyone needs this loan.

There are two kinds of people currently. First are those whose finances are impacted due to this crisis (due to pay-cuts, salary deferrals, loss of revenues for business / professionals, etc.). On the other hand, there are those whose financial lives are still more-or-less on track.

And it’s actually the first category that needs a helping hand. For people in the second group, it must be said that a personal loan being available at reduced rates does not mean that they should opt for it. A loan is a loan after all. And interest has to be paid on the amount being borrowed (and interest arbitrage play is best left to professionals).

These ”COVID-19” personal loans, as of now, could be only available to existing bank customers with good ratings (those having a salary account with stable jobs) or borrowers who have good credit history. Remember, lenders are in this for business too (though this time the heart is at the right place as well). But they still need to make profits. And the relaxation in the form of low rates (at least a few percentage points lower than regular personal loans) is genuinely helpful. But money would still not be lent to those who do not have good track records as borrowers.

Moratorium on repayments

As an added measure, lenders are also offering a moratorium period on these personal loans. This will provide relief for borrowers, at least for a few months, during which they would expect things to normalize. But what shouldn’t be forgotten is that the moratorium isn’t an interest or waiver. Interest continues to accrue and gets added to the overall repayment costs of these personal loans.

So to those considering taking these loans need to understand something more:

Let’s say you are taking (or planning to take) this loan because you have liquidity issues. But after a few months, repayments will begin mandatorily. So, if you believe your liquidity issues will be resolved with certainty very soon, then taking this loan route is fine. But if you have doubts and feel that you will continue to remain under liquidity stress for some more time, then think about it:  how will you manage the additional burden of the COVID Personal Loan? Many are taking these loans hoping to get moratorium extensions. Don’t do that. Your hope cannot be a strategy and it can backfire during tough times.

If you don’t see things improving soon, then avoid taking these loans if possible.

This is the time to utilize your emergency fund if you have one. If you don’t have it and instead have investments for your long-term goals, consider using them partially if things are getting really tight for you.

Ideally, you shouldn’t be dipping into your long-term savings. But if you really have no other means or help at hand, and foresee cashflow issues, then you wouldn’t want to be in a situation where you take a loan and are further burdened by any equated monthly installment (EMIs) you might be having.

Taking personal loans should be your last resort. More so when you aren’t sure about the stability of your future cashflows and see a possibility of disruption getting further extended. And it goes without saying that being frugal and cutting down your non-core expenses is a no-brainier if you see a need to borrow now.

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