Ways to avoid loan traps

Review total repayment cost, not just interest

By Cleofe MacedaSenior Reporter
00:00 July 2, 2012

Getting a personal loan may be as easy as borrowing money from a close friend or relative, but there are some booby traps to watch out for. Here are a few expert tips to keep in mind to ensure you won’t get further into financial strife:

• Before applying for a loan, ask yourself first whether you really need the extra cash or not. “It can be very easy to borrow the money, but you will be repaying the money back long after the cash has been spent,” says James Thomas of Acuma.

• Review all the costs of the offer, including all the fees and charges built into the repayment amount, not just the interest rate. “It is not unusual to see a rate of 22 per cent per year or more, and it might not apply to the reducing balance, but to the entire loan for the life of it. Additional charges may push up the profit to the bank also,” says Steve Gregory of Holborn Assets. Thomas suggests looking at independent websites and their loan calculators to see if you are being charged as advertised.

• Calculate how much will be the total amount repayable and the monthly instalment. “It’s a good idea to look at the whole cost of the loan over the whole period, when comparing prices,” says Gregory.

• Make sure you can comfortably afford the repayments no matter what happens and understand exactly what any credit shield will provide and when. For example, when you lose your job, what exactly is insured?

• Should you choose a short-term or long-term loan? Thomas says it is generally best to pay off a loan in as short a time as possible as this will reduce the amount of interest that you will pay, but it is best to arrange the loan with a repayment amount that you can afford so as to avoid any problems further down the line.

• Watch out for early settlement fees. When you decide to repay your loan in full prior to the end of the term, banks will charge you an extra cost. “You should be aware of all the terms and conditions of the loan, and this is just one of them. You should be aware of this in the event that you wish to settle the debt early,” says Thomas. Bear in mind that banks vary in how they rebate profit already charged if loans are repaid early, adds Gregory.

• Don’t by misled by the numbers. Banks charge either fixed or floating interest rate. The fixed rate will give you security that you will know what your monthly repayment will be, but it is likely to be higher than the floating rate, says Thomas. However, the floating rate could increase if interest rates move up at some point in the future, and so your repayment amount will increase. The best way to find the best deal, therefore, is to match the overall cost with that of another bank. “Fixed rates appear better at first glance, but may be charged on the full balance rather than the outstanding balance at any time,” says Gregory.

• Do your best to overpay by one or more payments so that if an emergency arises, you will not immediately default. “Default means the bank issues a police case against you which can lead to imprisonment if the total outstanding is not cleared in full on demand,” warns Gregory.