Using personal loan for debt consolidation? The pros and cons of this move

Managing high-cost debt is essential for alleviating stress and advancing towards your financial objectives. It is crucial to develop effective strategies for handling such debt. In the face of accumulating EMIs and high interest rates from substantial high-cost debt, you may find yourself depleting your savings. However, an alternative solution that can come to your aid is opting for a low-cost, long-term personal loan designed for debt consolidation.

Benefits of consolidating debt with a personal loan

The benefits of opting for a personal loan to consolidate your high-cost debts into a single loan with a potentially reduced interest rate include:

• Streamlined management: You’ll be dealing with a single monthly payment instead of multiple ones, simplifying the tracking and management of your debt.
• Possibly reduced interest: If the interest rate on the personal loan is lower than the average rate of your existing debts, you have the potential to save money on long-term interest charges.
• Lessened stress: Consolidating your debt payments can alleviate stress and instill a sense of control over your financial situation.

Opting for personal loans is a possibility, but securing a favourable interest rate hinges on your creditworthiness and financial standing. Nevertheless, if the interest rate on the personal loan surpasses the average rate of your current debts, consolidation may not prove advantageous. It is crucial to refrain from accumulating additional debt while utilising a personal loan for consolidation.

A caveat for borrowers

Before selecting a personal loan, obtain quotes from various lenders and carefully compare interest rates, fees, and terms before reaching a decision. Additionally, it is imperative to create a practical budget to guarantee that you can comfortably manage the monthly payments for the consolidated loan. To enhance your credit score and work towards becoming debt-free, ensure timely and consistent monthly payments.

Debt consolidation is merely one instrument in your financial toolkit. It is crucial to employ it responsibly and in conjunction with other financial strategies to effectively manage your debt and attain your long-term financial objectives.

Frequently Asked Questions (FAQs)

Q. What is a personal loan tenure?

The tenure of a personal loan denotes the overall period, usually stated in months or years, within which you are required to settle the borrowed sum and the associated interest. Essentially, it establishes the duration during which your loan remains active and the period over which you’ll make monthly payments through equated monthly installments.

Q. What is the effect of personal loan tenure on your overall interest expenses?

The duration of your personal loan plays a crucial role in determining the total interest cost you incur. Here’s an analysis of the connection:

- Opting for a shorter loan tenure: Accelerating the loan repayment results in a lower overall interest payment. This is attributed to the interest being calculated based on the remaining loan balance, which diminishes more rapidly with shorter tenures. Nevertheless, opting for a shorter loan tenure necessitates larger monthly payments for timely repayment. This may impose strain on your monthly budget, particularly if the loan amount is substantial.

- Opting for a long loan tenure: With an extended loan term, the accumulated interest over time increases. This is because you’re paying interest on the outstanding balance for an extended duration. Stretching the repayment across a more extended period results in smaller monthly payments, potentially making them more manageable within your budget.

Q. What factors should you consider when deciding on your personal loan tenure?

When choosing the tenure for a personal loan, it’s essential to assess various factors that align with your financial situation and objectives. Here are crucial factors to contemplate when deciding on the tenure for a personal loan:

- Your financial plan: Are you able to handle the increased monthly payments that come with a shorter loan duration? Take into account your necessary expenditures, current debts, and other financial obligations. Do you anticipate any future financial objectives that might demand extra funds? Opting for a shorter loan term could expedite fund availability, while a long term might provide greater short-term flexibility.

- Your fiscal stability: Do you have a reliable income stream to guarantee steady loan repayments throughout the selected duration? Are you expecting a potential rise in income in the future, which could potentially make it more feasible to manage higher EMIs associated with a shorter loan tenure?

- Burden of interest cost: Opting for a short loan duration results in reduced total interest paid but entails higher monthly EMIs. Opting for an extended loan duration results in increased total interest paid but entails lower monthly EMIs.

- Your ability to withstand or handle risk: Selecting a shorter loan term reduces the time available for unforeseen circumstances to affect your repayment capacity, potentially providing peace of mind. Conversely, a lengthier tenure offers more flexibility in the face of unexpected financial challenges but entails higher interest costs.

- Options and penalties associated with prepayments: If the lender permits penalty-free prepayment, you have the opportunity to potentially settle the loan ahead of schedule and save on interest in case your financial situation improves. Take into account the potential interest discounts offered by some lenders for early loan repayment when deciding on the loan duration.

Q. Can you claim tax benefits on your personal loan?

In the majority of instances, tax benefits cannot be availed on personal loans in India. Personal loans are generally categorised as unsecured loans intended for personal expenses, and the interest paid on them does not meet the criteria for tax deductions under the Income Tax Act.

Here’s an analysis of why personal loans typically do not provide tax advantages:

- Unsecured loans: In contrast to secured loans such as home or education loans, personal loans do not entail the creation of any assets and are predominantly utilised for personal consumption. The tax regulations typically do not encourage tax deductions for personal expenditures.

- Taxable income: Personal loans are not deemed as income, and the borrowed amount is not incorporated into your taxable income.

Nevertheless, there are some exceptional situations in which you may be eligible to claim tax benefits on a portion of the interest paid on a personal loan:

- Used for business purposes: If you can establish that a portion of the personal loan was used for business-related activities (such as acquiring equipment or inventory), the interest paid on that specific portion may be eligible for partial tax deduction as a business expense. Nevertheless, maintaining thorough documentation is imperative to avail of this benefit.

- Home renovation (conditions apply): Occasionally, if a personal loan is exclusively utilized for home renovation and specific criteria are met, a tax deduction of up to ₹30,000 on the interest paid may be applicable. However, this deduction is contingent upon particular limitations and eligibility criteria. It is advisable to seek guidance from a tax professional for comprehensive information.

Q. What are the benefits of personal loans compared to salary advance loans?

Personal loans present numerous benefits over salary advance loans, potentially making them a superior choice for diverse borrowing requirements. Here's an overview of the primary advantages:

• Increased loan amount: Personal loans permit borrowing more substantial amounts compared to salary advance loans, which are generally confined to a percentage of your monthly salary. This flexibility makes personal loans well-suited for covering significant expenses such as medical bills, home renovations, or debt consolidation.
• Flexible repayment terms: Personal loans provide extended repayment periods in contrast to salary advance loans, which are frequently limited to a few months. This flexibility results in lower monthly payments (EMIs) for personal loans, potentially making them more manageable within your budget.
• Lower interest rates: Personal loans typically come with lower interest rates when compared to salary advance loans. This can substantially decrease the overall cost of borrowing throughout the loan term, leading to potential savings in the long run.
• Improved credit score: Personal loans, when repaid responsibly, can have a positive impact on your credit score. Punctual repayments showcase your creditworthiness, potentially facilitating easier and more cost-effective borrowing in the future.
• Greater flexibility in utilisation: Personal loans can be used for various purposes, unlike salary advance loans, which are solely meant to bridge the gap until your next pay check. This versatility allows you to use a personal loan for various needs, offering greater financial flexibility.