1.Taking a loan to buy a car or any consumer durable (air conditioner, washing machine, mobile phones etc)
Never take a loan to buy any product which depreciates in value (depreciation means losing value every day) You will get hit on 2 counts, viz: you are paying a high rate of interest / EMI which will burden your finances every month and ALSO you are paying this EMI for something which is losing it’s value every day.
Example: A new car loses its value the day it goes out of the showroom.
Instead, save money and buy the product that you really need, using your savings
The only time you should ever take a loan is to BUY A HOME to stay. As home / land prices usually always appreciate, you will be doing a wise thing.
2.Taking a loan without understanding the exact (effective or hidden) rate of interest
Many people see advertisements talking about 6.99% or 7.99% interest rate and believe that such low interest rates are true.
Ask the lender whether the rate of interest is calculated on “Monthly Reducing Balance” or “Flat rate”. Remember the difference- Flat rate of 6.99% means that the lender is charging you rate of 6.99% for the entire period of the loan, even though you will be paying EMI every month. You are not getting the credit of the EMI.
Example: A flat rate of 8 % is ACTUALLY 14.55 % on monthly reducing basis and the internal rate of return (IRR) is 15.56 %!!!
You would be better off, using your savings to buy that product, instead of paying such a high rate of interest.
3.Taking a loan without understanding the hidden extra charges (processing charges, application charges etc)
Many banks and finance companies add additional charges that finally increase the actual rate of interest on your loan. Negotiate hard and get them to waive off all the other additional charges. This will reduce the effective cost of your loan.
4.Taking a loan from a small finance company rather than a well known bank
Large and well-known banks always have lower cost of funds, as their deposit rates are always lower than finance companies. So their loans will always be at a lower rate of interest. Always take a loan from a large well-known bank rather than a finance company, even if that means additional paperwork, because you will enjoy lower effective rate of interest.
5.Taking different loans for buying different things without knowing the dangers
Minimize the need to take multiple loans, as you are sacrificing your future for enjoying the present. Your savings get depleted due to many EMIs. The total amount you pay of all the EMIs put together should never exceed 40% of your net take home salary. You will need the remaining 60% to meet your living expenses and to save something for emergencies and for the future.
What will happen if you were to lose your job or incur a loss in your business due to any reason OR if you need money in an emergency??
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