5 crucial dos & don’ts before applying for a loan

Loans can be extremely helpful in meeting the financial shortages stopping you from achieving your financial goals. However, loan approval primarily depends on your credit risk assessment by the lender, based on your credit score, income, job profile, etc. Choosing the right lender also becomes necessary as the interest rates and fees charged by them can vary widely.

Here I will list some crucial steps to take before the making the final loan application.

1. Fetch your credit report before making your loan application
While evaluating your loan application, lenders assess your creditworthiness by checking your credit report. Usually, those with a credit score of 750 and above have higher chances of loan approval at lower interest rate than those with lower score. Lower score applicants are either denied loan approval or granted approval at higher interest rates.

Fetching your credit report before making the loan application will allow you to take corrective measures to improve your credit score. It will also help you identify any wrong information or clerical errors, if any, on the part of the lender or credit bureaus pulling down your credit score. A rectified credit score can increase your credit score and thereby, your loan eligibility.

Prior fetching of your credit report might also get you pre-approved loan offers through the credit bureaus or the online financial marketplaces based on your credit score, income, job profile, etc. These pre-approved loan offers might give you a fair idea about your loan eligibility for further comparison.

2. Ensure to compare loans available from various lenders
Lenders approve loan applications and set their interest rates primarily on the basis of their cost of funds and credit profiles of loan applicants. This may lead to the interest rate range for the same loan type to vary widely across the lenders. Hence, it is important to compare the loan offers from a wide spectrum of lenders to land with the best loan offer.

A loan applicant should first approach his existing bankers and lenders, if any, on the availability of the loan he is seeking and its features. Then, he should visit online lending marketplaces to compare the various loan offers offered by other lenders on the basis of his monthly income, credit score, job profile, employer’s profile, etc. The final loan application should be made with the lender charging the lowest interest rate, fees, etc for the optimal loan tenure and margin money.

3. Opt for a loan tenure on the basis of your repayment capacity
Loan tenure plays an essential role in determining your EMI outgo and total loan cost. Ideally, selection for loan tenure should be based on your repayment capacity. Shorter loan tenures result in higher EMIs and lower interest cost and vice versa. Thus, opt for a shorter loan tenure if you can pay your EMIs on time without sacrificing your contributions to your essential financial goals. In case you cannot, choose a longer loan tenure for lower EMIs.

4. Avoid loan applications with multiple lenders within a short span of time
Each time you submit a credit application, lenders fetch your credit report from the credit bureaus to evaluate your creditworthiness. Such credit report requests initiated by the lenders are considered as hard inquiries, each of which will lead the credit bureaus to reduce your credit score by a few points. Hence, making direct loan applications with multiple lenders within a short span can significantly reduce your credit score, thereby reducing your loan eligibility.

Instead, visit online financial marketplaces to make loan enquiries across a wide spectrum of lenders. While these marketplaces too will fetch your credit report to provide you the loan offers, credit report requests by them are considered as soft enquiries and does not reduce your credit score.

5. Ensure to factor in your new EMI in your emergency fund
Financial emergencies like medical illness, job loss, etc come unannounced. These emergencies can disrupt your future income and cash flows and thereby, your future loan repayment capacity. Failure to make loan repayments by the due date will not only cost hefty penalties, it will also adversely impact your credit score. While you can redeem your investments to make loan repayments, doing so can adversely impact long term financial health.

The best way to prepare for such future uncertainties is create an appropriate back-up in the form of an emergency fund. This fund should be at least six times of your monthly mandatory expenses including your existing and new loan EMIs. Hence, as soon as you start planning for a new loan, try to simultaneously increase the emergency fund’s size by at least six times of the expected EMI of the new loan.