3 Major Pitfalls to Avoid when Taking Personal Loans

Personal loans are a great financial tool that could provide Malaysians with quick relief in times of financial need. You can apply personal loans towards a wide variety of financial needs without having to worry about misappropriation of funds. The best part is that personal loans tend to attract a lower interest rate than credit card loans; hence, they are a great tool for refinancing or consolidating high interest debt.

Nonetheless, personal loans are not perfect and there are certain drawbacks associated with them. However, a financially enlightened borrower knows some of the potentially troubling issues associated with personal loans but many Malaysians often plunge headlong into the pitfalls. This article provides insight on three major pitfalls you should watch when you want to get a personal loan.

1) Understand how the origination fee works

You might not be able to avoid paying an origination fee on your personal loan because most lenders do charge an origination. However, an understanding of the origination fees can help you shop around for the best deal so that you don't pay more than necessary. The origination fee is different from the interest rates and it one of the costs associated with processing a personal loan request – it is usually shifted to the borrower.

Some lenders charge a 3% origination fee and others could charge in excess of 5%, you need to be sure you know how much you'll pay as origination fee before you get a personal loan. The more troubling pitfall to avoid with origination fees is that the lender usually deducts it from your loan right from the onset. Hence, if you requested for a loan of MYR10,000 and 15% APR with an origination fee of 5%, you'll receive an upfront loan of MYR9,500 instead of MYR10,000.

The more painful part is that you'll need to pay back the interest on MYR10,000 and you'll need to pay back the MYR10,000 in full as well. Hence, if you really need MYR10,000, an that you can be left with actual MYR10,000 when the loan is approved. More importantly, make sure you understanding of the origination fee would give you insight to request for MYR10,550, so shop around for a loan with the best origination fee.

2) Think twice before buying insurance bundled with a loan

When you are taking a personal loan, you should get your guards up against any sales pitch that comes your way – you'll hear quite a lot of sales pitches. One of the commonest sales pitch you'll hear are adds on offering you insurance policies when the loan is about to be finalized.

They might offer you a Life Insurance policy to cover the repayment of the loan in the event of your untimely demise. The premise of the life insurance policy will sound logical because you wouldn’t want to saddle your family with the responsibility of repaying a loan in addition to their grief when you die. However, repaying a loan is just one of the many worries that your family would have when you die; hence, it makes more sense to look for a comprehensive life insurance policy instead of buying a policy that covers the repayment of the loan alone.

They might also offer you Unemployment Insurance, which is a type of insurance that will continue your loan payments if you suddenly lose your job. The unemployment insurance makes a decent case because won't easily get a standalone insurance policy that will take care of loan payments if you lose your job. However, you need to explore all your options before you sign up for the policy.

You might observe that the insurance policy doesn’t offer you value for money when you add up all the premium to the interest payable on the loan. If you job is stable and there are no undercurrents that could cause you to be out of a job in next one year, you should think twice before buying unemployment insurance.

3) Avoid pre-compute interest

The last pitfall you must avoid when taking personal loans is the pre-compute interest strategy. Nothing good ever comes out of a pre-compute interest strategy, if you lender insists on pre-computing your interest, walk away. The pre-compute interest strategy is a complex way of calculate interest payable on a loan to ensure that you are penalized if you decide to pay off the loan earlier before the duration of the term.

In a pre-compute interest calculation, the total amount of interest payable is added to your loan amount and it becomes your balance due. Hence, if you take a MYR5000 loan and the total interest payable at the end of the term adds up at MYR1000, your loan balance will become MYR6000 instead of the original MYR5000 + interest. Hence, if you decide to pay off your loan two months after you obtained it, you'll still be required to pay a balance of MYR6000. Of course, the lender will do an interest refund calculation, but you'll still end up with the short end of the stick.