A bank loan can be useful to pay for large expenses, such as your dream home or even to fund some elaborate home improvements. They usually have reasonable interest rates as long as you have good excellent credit and you make your monthly loan payments on time. However, as with any financial decision, there are positives and negatives to getting a bank loan. Here’s what you need to know about the advantages and disadvantages of a bank loan before you apply.
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Advantages
1. Flexible Spending
There are many types of bank loans. Bank loans with a specific purpose, such as a mortgage loan or a car loan, tend to have lower interest rates. However, there are personal loans that offer flexible spending. You can use this loan for just about anything. Some have even taken a personal loan to pay for a wedding or a lavish vacation. Unlike borrowing from your friends and family, there is no judgment associated with how you use the funds.
2. Flexible Loan Terms
Bank loans can be a great short-term financial option if you only need a temporary loan. Most banks offer a minimum loan tenure of one year. However, there are also medium-term financing options, such as a car loan, which can be as long as 7 years. Finally, of course, there are long-term loan tenures for extremely large purchases, like a mortgage. Always choose the shortest loan tenure you can afford to save on the interest payments. The longer the loan tenure, the more interest you pay on your loan. However, you can always adjust your monthly payment amount to make it more affordable. Bear in mind that the lower your monthly payment, the longer your loan tenure. You will always need to pay back the principal amount, plus interest.
3. Mainstream Process
Unlike borrowing from friends and family members, the process for a loan application is fairly mainstream and standard. There is a process of producing the appropriate documents, filling out the application, and then waiting for approval. In fact, a bank loan’s eligibility requirements are transparent and can even be found on the bank’s website. There are no hoops to jump through, no justifications to be made, and no compliments to give. A bank loan can be approved within a few hours and your funds will usually be deposited into your account within a few days.
4. Lower Interest Rates
A bank loan usually comes with lower interest rates than credit cards and moneylenders. If you max out your credit card or fail to pay your balance in full, your credit score will suffer. If you take a cash advance from your credit card, you will pay numerous fees in addition to high interest rates, which are compounded daily. A cash advance is never a good option. On the other hand, borrowing from a licensed moneylender is usually easier than applying for a bank loan. However, these types of loans usually come with higher interest rates than a bank loan because moneylenders tend to accommodate people with less than perfect credit. High-risk borrowers have higher interest rates.
Disadvantages
1. Strict Approval Process
Bank loans have more stringent requirements for approval, making them more difficult to get. For example, bank loans are designed for persons with good to excellent credit. Your credit score will determine if you get approved and how favorable your interest rate and terms will be. This is, of course, assuming you have all the proper documentation and meet all the qualifications that accompany your application. For instance, you will need legal identification proving your age and identity, such as your Singapore National Registration Identification Card or NRIC, passport, and employment pass. You will also need proof of residence, which can be found on recent utility bills or your apartment lease agreement. However, these documents must have both your name and address are on them. Depending on your employment situation, you may also need your most recent 12 months of Central Provident Fund contribution history statements, your latest Income Tax Notice of Assessment, and/or your most recent computerized payslips. Naturally, there is also an income threshold requirement and a debt-to-income ratio, which makes sure you can actually afford the loan. Each bank has different criteria for their loan application, which makes your life more complicated.
2. Potential to Negatively Impact Your Credit
A bank loan can either help or hurt your credit. I categorize this power as a disadvantage because it is much more likely that you will forget and subsequently miss a payment, which can lower your credit score. If you miss your monthly installment, a lender may consider your loan to be in default after 30 days from your missed payment. Some banks allow 60 to 90 days before reporting the delinquencies. However, more than two late or missed payments will definitely bring your score down. In Singapore, more than three missed payments mean your loan account is automatically considered in default. No matter how great your credit score was when you took out the loan, if you miss your monthly payments, your credit score will plummet incredibly fast. On a more optimistic note, if you diligently back your loan in full and on time, a bank loan can help improve your credit over time. The key phrase is "over time." Improving your credit by simply making your payments is a very slow process.
3. The Penalties for Missing a Loan Payment
Banks are usually extremely unyielding when it comes to a late payment. Some banks charge a percentage of the outstanding balance, while others charge a flat fee. It is always better to try to pay back your missed payment, even if there is a penalty. Paying the penalty is better than your loan account going into default. If you miss several payments, the bank may even increase your interest rate on your outstanding balance. Your loan tenure will likely also be extended so your monthly payments stay the same. However, this still means that by the end of your loan, you will have paid more than what you first agreed upon because of the extra interest payments.
4. Collateral and Legal Action
If you have any form of collateral attached to the bank loan, you may potentially lose your collateral if you fail to make your payments. This may be extremely stressful, especially if the purpose of the personal loan was to help make ends meet. If you did not have collateral on your loan, for example, if you took out an unsecured personal loan, the bank may pursue some type of legal settlement if you default. Your bank accounts may be seized and the lender may turn to one or more of your assets to get their money back.
5. Other Fees and Conditions
Some bank loans have a prepayment penalty, amongst other fees and conditions. This means that even if you suddenly come into a large amount of money and want to get out of debt immediately, you will end up paying a penalty for doing so. Be sure to know the terms of your loan.
Final Thoughts
There are numerous advantages to a bank loan. The big disadvantages arise if you fail to pay the monthly installments on time. Banks are fairly serious about repayment and will do all that they can to get their money back. Therefore, only take out a bank loan if you truly need it and be sure that you budget well and can afford to make the monthly payments. You should also know all the terms and conditions associated with your loan contract. With these things in mind, you will be able to use a bank loan how it is actually designed and to your advantage.
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