How much personal loan should you take to avoid default

If you are facing a financial crisis or an urgent need for money, it is natural to borrow. However, it is essential to realize that the loan amount should remain within a comfortable range. This means one should not borrow so much money that it becomes too much to repay.

How much is too much?

It is vital to note that several banks, NBFCs, and fintech platforms are willing to offer personal loans at a high rate of interest. But you should be careful not to borrow more than you can afford to repay.

Typically, the borrower is expected to keep the EMI amount lower than 50 percent of monthly income, while it is better to keep it below 40 percent.

“We often tell our clients to keep their monthly EMIs below 40 percent of their income. Regardless of temptation, one should not borrow beyond their means of repayment,” says Deepak Aggarwal, a Delhi-based chartered accountant and wealth advisor.

What are the factors to consider?

There are a number of factors to consider before going ahead with a loan. These include the following:

A. Urgency of loan: Whether the loan is essential, i.e., whether it is for a wedding or vacation. If you are borrowing money for something as urgent as a wedding, then you should go ahead. Else, you can drop or at least defer your plan to borrow if it is meant for a luxury.

B. Rate of interest: The quantum of EMI is a function of the rate of interest and the amount of loan. If your loan is too small but the interest rate is too high, then the EMI can also be exorbitant. So, one should be wary of borrowing money at a high rate of interest.

C. Current income: You should borrow money based on your current income instead of your projected future income. If your current income can support you in repaying the loan easily, you should go ahead with it. Conversely, the practice of raising a loan on an ‘assumption’ that your income will spike shortly is not recommended.

How bad is it to default on a personal loan?

Defaulting on a personal loan in India can significantly damage your credit score, making it more challenging to obtain future credit or personal loan approvals.

You may even face legal action, persistent collection calls, and financial stress. That is why one should focus on repaying on time to avoid penalties, increased interest, and loss of credibility with banks and financial institutions.

Defaulting on a personal loan can lead to charges under several legal sections:

1. Section 138 of the Negotiable Instruments Act, 1881: This legal provision covers cheque bounce cases related to loan repayments, which may lead to criminal proceedings if post-dated repayment cheques are dishonoured.
2. Section 420 of the Indian Penal Code (IPC): Applies to wilful default involving fraudulent intent, cheating, or misappropriation. If a borrower is charged under this section, it can result in up to two years of imprisonment.
3. Sections 403, 406, and 415 of IPC: This is a legal provision that deals with criminal breach of trust and cheating. One can be charged under this if the lender proves deliberate deception or misappropriation of funds.

Hence, consistent and on-time repayment protects the borrower from these legal consequences and preserves their credit score.

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