Personal loan management need not be painful
Personal loans are a powerful tool, if used responsibly. However, there are some situations where we might feel we’re in over our heads - especially if we’ve had to take a large and unexpected loan, such as for emergency home repairs. If this happens to you, don’t panic - here are some simple steps to get the loans back under control:
1. Avoid having multiple debts; always try to consolidate them under the cheapest possible loan
Say you owe S$1,560 in personal loan A, S$4,100 in personal loan B, and have perhaps S$780 debt on a credit card.
This can be a headache to track, as each of those debts has a different interest rate. The billing cycle (the time given to make repayments) also differ, making it harder to plan your monthly repayments.
In this instance, a good solution is to consolidate all the debts into one. For example, you could search SingSaver for a personal loan with the lowest rate (as low as a nominal rate of 3.7 per cent per annum). You could then take out a loan for S$2,381, and pay off all of the debt mentioned above.
You would then make only a single repayment a month, toward this consolidated debt. Not only is it simpler, you’ll save money if the interest rate on the consolidated debt is lower than the others.
2. Automate your debt repayments
Have your bank automatically put money into repaying your debts, the moment you receive your paycheck. This will remove the temptation to spend on other things, whilst you still have debt repayments to make.
If you do this, however, it’s important to also stop all use of credit facilities. As you don’t “feel” the sting of debt repayments, you could be tempted into taking on even more debt.
3. Have a family process for use and repayment of personal loans
If you have a spouse or children that still depend on you (though they may work and qualify for loans), institute a family process for use of personal loans
An example is to have a family meeting, before taking out any loan in excess of S$500. The family should decide if they can help the intended borrower cover the cost “in-house” rather than using bank facilities. There should also be a serious discussion on whether such a loan is really necessary (e.g. is it really important to buy a S$2,000 laptop when a much cheaper one would suffice?)
If there’s existing debt, the family should discuss this at least once a month. It’s important for parents to keep tabs on young working children: if your 19-year-old racks up a S$10,000 personal loan, for instance, you need to be aware of what’s going on and put a stop to it.
It’s important to be open about the use of loans, as it can be devastating to find out - unexpectedly - that a family member owes a large sum. It’s also important for family to work together, to clear off debts that ultimately affect the whole household.
An example would be paying off the debt for your children to prevent interest from accruing, on the agreement they’ll make regular, interest-free repayments to you.
4. Use interest-free loans if you can finish off the debt in six months
Consider if you can pay the outstanding loan in six months. If you can, it may be worth taking an interest-free loan to pay it off.
Most interest-free loans charge no interest for six months, after which they revert to the normal interest rate. An example of this would be a balance transfer on a credit card.
This can save you a lot of money, as six months’ interest can come up to quite a sum. However, you must be absolutely certain that you can repay the entire remaining loan within the six month period.
Also, do check if there are prepayment penalties, for paying off the loan early. These differ between banks and loan packages. If there is a prepayment penalty, it’s usually not worth using a balance transfer.
5. Impose a debt ratio on your own budget
A debt ratio measures how much your income goes toward loan repayment. For example, if your combined household income is S$10,000 a month, and your total repayments of all loans comes to S$3,000 a month, then your expense ratio is 30 per cent.
To be financially prudent, your total debt ratio (inclusive of loans such as home loans and car loans) should not cross 40 per cent. If it exceeds this amount, you need to budget for more aggressive loan repayments, to pay down your debt. Consider setting aside a greater portion of your monthly paycheck - say an extra 20 per cent - toward bigger loan repayments.
Before taking another loan, you should always consider whether it would cause you to exceed your debt ratio.
6. Be systematic in your repayments
Always prioritise paying off the highest interest loans, before the lower interest loans. This minimises the total you’ll spend on interest repayments.
If you find that you have a big assortment of unpaid loans, all at different rates, then try to consolidate your debt before you start prioritising repayments (see point 1).
In general, you should pay loans in the following sequence:
- Credit card loans
- Personal loans
- Car, renovation, and education loans
- Home loan
7. If you can’t cope with the repayment, talk to your bank or a credit counsellor. Never keep it to yourself and let it get worse.
Some situations could make it impossible for you to keep servicing a personal loan. Examples could be an illness that stops you from working, or legal situations such as divorce.
In these cases, never keep quiet and ignore the bills. You’ll simply make things worse, as the interest will snowball your debt. Approach a credit counsellor or your bank, to restructure your loan.
Banks can take steps such as extending your loan tenure, or even accepting a lower interest rate, if you truly can’t make your repayments. This will affect your credit score negatively - but the damage is much worse if you default (don’t make any effort to pay at all) on a loan.
Remember: a lowered credit score can be fixed over time; but if you default on a loan, it remains on your record indefinitely.
Note that without restructuring your debt, it can become impossible to pay as the interest keeps compounding. The sooner you reach out, the less financial damage you’ll suffer.