Here are the top 5 reasons you should stay away from personal loans.

1. Personal loans are a quick debt trap

Getting a personal loan is a cakewalk for any salaried person. With an average salary of about Rs.25000, you could get a loan of up to Rs.5 lakhs very easily. What's more, you do not have to give the bank any security and in some cases you don't even require a guarantor.

The process seems so simple that people feel they are borrowing money from a friend. Well, the bank is not your friend and you are putting your finances in jeopardy.

2. Personal loans are unproductive

The end use of a personal loan is unknown. You could take a personal loan for travel/ holiday, your daughter's wedding, new furniture for your home, medical expenses or for repayment of a debt.

Such purposes do not add to your assets, which appreciate in value. These are just consumption items or liabilities. Hence, you are borrowing money for something that is not going to add to your financial wealth or assets.

3. The rate of interest is high

The rate of interest for personal loans is much higher than other loans. The current rate of interest for personal loans is 18% to 20 %. However, the rate could even go up to 30% in certain cases.

Also, there is no option of a floating rate of interest when it comes to personal loans. You have a fixed rate of interest throughout the loan term. The loan term could extend up to five years.

4. There is no option of part prepayment

Personal loans do not give you the option to pay of part of your loan mid term.

Let's say you have taken a loan of Rs.5, 00,000. You have finished paying Rs.1, 00,000 of it. Now you want to pay Rs.2, 00,000 in one go. This is not permitted. Either you pay Rs.4, 00,000 in one go (i.e. the remaining loan amount) or continue with the regular EMI (Equated Monthly Instalments) system.

Also, don't forget that there are prepayment penalty charges.

5. Personal loans are unsecured

Unlike in the case of a home loan, where your house is the security for the bank, there is no security for personal loans. Therefore, in order for the bank to be sure of repayment from you the interest rate is approximately 5% to 10% more.

Smart Tips to Avoid Personal Loans

• Always put aside part of your income into a contingency fund. This way you won't have to borrow money if a medical emergency arises.
  
  
• Set financial goals in advance. For example, your daughter's wedding shouldn't take you by surprise. Start saving for the occasion well in advance.
  
  
• If you are redoing your home, take a home improvement loan. The rate of interest is much lower than that of personal loans.
  
  
• When buying that super cool plasma TV, the EMI system that the dealer offers you is far cheaper.
  
  
• If you have some long term plans (above five years), invest in diversified equities. However, it would be safer to invest in debt funds or bank FDs if you belong to the older age group.

(With inputs from Hemant Mehta, Chartered Accountant)