How to pick the right personal loan tenure? Avoid THESE costly mistakes | Mint

While taking a personal loan, it is important to choose the optimum tenure. If the tenure chosen is longer than required, the borrower will end up paying more interest. If the tenure chosen is shorter than required, the higher EMI can put pressure on the borrower’s cash flows and disturb the monthly budget. In this article, we will understand the mistakes a borrower should avoid when choosing a personal loan tenure and how to choose the optimum tenure.

What is a personal loan tenure?

A personal loan tenure is the period over which a borrower will pay monthly EMIs to repay the loan. Usually, a personal loan tenure ranges from six months to five years. However, some financial organisations may offer lower or higher tenure than the above-mentioned range. Personal loan tenure can also be termed as the period between the loan disbursal and the last EMI payment.

The bank or NBFC gives the borrower various personal loan tenure options to choose from. Once the borrower chooses the tenure, it is mentioned in the loan agreement. Based on the loan amount, interest rate, and tenure chosen, the financial institution calculates the EMI. Thus, the personal loan tenure is mutually agreed upon between the borrower and the financial institution before the loan is disbursed.

Mistakes to avoid while choosing a personal loan tenure

Now that we understand what a personal loan tenure is, let us discuss the mistakes to avoid while choosing the tenure.

1. Choosing a higher tenure: Some borrowers opt for the highest tenure being offered. The reason is that a longer tenure will result in a lower EMI. Some people choose a longer tenure than required to be on the safer side. When a borrower chooses a longer tenure than required, the EMI will be lower. A lower EMI is easy on the pocket, and the borrower can pay it conveniently.

However, the longer the personal loan tenure, the more interest the borrower will pay. So, if you choose a longer tenure than required, you will end up paying a higher interest amount.

2. Choosing a lower tenure: Some borrowers take a personal loan to tide over a short-term emergency. As a result, they choose the lowest tenure being offered. The reason being they want to repay the loan and get rid of it at the earliest.

In some cases, the borrower may end up choosing a tenure lower than required. A lower tenure will result in a higher EMI. A higher EMI, if not planned for in advance, can leave a borrower with a lower amount for monthly expenses.

A lower tenure with a higher EMI can increase the borrower’s debt-to-income (DTI) ratio. The DTI ratio measures the percentage of monthly income used to pay debt obligations like loan EMIs. Banks consider a DTI ratio of lower than 35% good for giving loans. Hence, the loan tenure chosen should be such that the EMI keeps the DTI ratio within the bank’s specified limits.

3. Not considering the monthly budget: While choosing a personal loan tenure, the borrower must check if the EMI can be accommodated into the monthly budget. What if the borrower doesn’t have sufficient money after paying the EMI? They may have to rework their monthly budget for expenses, savings, and investments.

The borrower may have to divert some money meant for financial goals towards paying the personal loan EMI. Some borrowers may have to cut some of their discretionary expenses to accommodate the higher EMI.

Hence, a borrower needs to choose the optimum tenure. They must ensure the tenure is not too long so that they don’t pay a higher interest amount. At the same time, they must ensure the tenure is not too short so that they don’t have to adjust their monthly expenses and investments.

Check the foreclosure fees

As discussed earlier, some borrowers choose a higher tenure to be on the safer side. After paying some EMIs, they may want to make a partial prepayment or foreclose the entire loan when they have surplus funds. However, most banks charge a fee for a partial prepayment and foreclosure.

The partial prepayment fee is usually a specified percentage of the loan amount prepaid. Similarly, the foreclosure fee is usually a specified percentage of the outstanding personal loan amount. Some banks reduce the fee in a slab manner after a specified number of EMIs have been paid. Some banks waive the fee after a specified number of EMIs have been paid.

The fees can reduce or nullify the interest savings benefit from a partial prepayment or foreclosure. Hence, you must check the partial prepayment and foreclosure fees before finalising the bank for taking a personal loan. A borrower must compare the partial prepayment and foreclosure fees across banks using a loan aggregator website or app. Look for banks that either waive the fees or have lower fees.

How to choose the optimum tenure?

Before choosing a personal loan tenure, the borrower must check their monthly budget. The budget will give an insight into the free cash flows available for the EMI payment. Once you have a fair idea of the monthly amount available for the EMI, you can work on choosing the personal loan tenure.

You already know the personal loan amount and the interest rate. Using a personal loan calculator, you can input the various tenure options to check how much the EMI is coming to. For whichever tenure the EMI amount is slightly lower than the free cash flow available in your monthly budget, you can opt for that tenure.

Thus, based on your repayment capacity, you can check the EMI, and accordingly choose the optimum loan tenure. The above approach will ensure the tenure is not longer than required, saving interest costs. It will also ensure the tenure is not too short, making EMI payments manageable.

You should also consider the partial prepayment and foreclosure fees. If the fees are waived or lower, you can use surplus funds, if any, to close the loan earlier than scheduled.

Seek professional advice

A borrower can consult a professional like a loan expert or financial advisor to choose the optimum personal loan tenure. The professional can help make the monthly budget to figure out the surplus amount available for the EMI. Based on the available amount, the professional can recommend the loan tenure to be chosen such that the EMI can be paid easily. The professional can also ensure the DTI ratio stays within the bank’s specified limits.

Stay in control of your personal finances with the right loan tenure

Choosing the right tenure for your personal loan has several benefits. It will prevent a higher interest outgo from your pocket, and pay the EMI amount smoothly. When the EMI amount is accommodated in the monthly budget, it will help you manage your expenses, savings and investments smoothly. Thus, with the right tenure for your personal loan, you will be fully in control of your personal finances.

Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.