Adulting 101: Interest rates, fees and credit reports – what to look for when taking out a personal loan from a bank

SINGAPORE – A month ago my editor assigned me to investigate a potential personal loan story and I realized I had no idea what the subject matter was – if it was necessary for me to take one in the future, I would not know where to start.

That was a little worrying considering I’m in my mid-twenties this year and will probably be moving into my next season in life soon, which means possibly taking out a loan for big-ticket items like a wedding or a home renovation.

While googling loans, I learned that one in three young adults in Singapore had “unmanageable debt,” according to a study by the Citi-SMU Foundation’s Financial Literacy Program for Young Adults, which surveyed 1,068 respondents aged 18-30 from March to April last year on topics such as debt and savings.

They asked respondents to provide an estimate of their total debt, including credit cards, student loans and other debt, but excluding mortgages and home loans.

They then compared this to their monthly household income to measure their ability to repay their debts.

Curious, I approached the program director, Professor Aurobindo Ghosh, to find out why such a large proportion of young Singaporeans had unmanageable debt, and he told me there were three common reasons:

First, a lack of a clear understanding of budgeting and expense tracking, exacerbated by the blurring of the line between needs and wants with more targeted advertising on social media and elsewhere.

“‘Following Joneses and Yolo (You Only Live Once) attitudes could lead young people into unsustainable debt to meet their personal consumption expenses,’ said Professor Ghosh, who is also an assistant professor of teaching Finance at Singapore Management University (SMU).

Second, the pandemic may also have reduced real income, or income after adjusting for inflation, which could have caused young people to spend higher sums or borrow money to make up for the shortfall. .

Finally, the widespread use of borrowing tools, including credit cards and buy-it-now-pay-later programs, without understanding the implications of borrowing, could also increase the total amount of youth debt. adults who are also more likely to use technology, Professor Ghosh said.

Having learned all of this, I then spoke to financial experts to better understand loans.

WHAT IS A PERSONAL LOAN?

A personal loan is an unsecured loan, meaning it is not backed by any asset. It is different from a home and car loan, where in the event that a borrower is unable to return the amount, the bank has the option of foreclosing the property.

A personal loan can be used for a variety of purposes, such as home improvements or the purchase of electronics, and the amount you can borrow depends on your ability to repay it, which is influenced by factors such as your monthly salary and your credit report.

WHAT IS A CREDIT REPORT?

Banks may ask for your credit report to assess your “creditworthiness” or ability to repay a loan before they give you one, explained Ms Lorna Tan, head of financial planning at DBS Bank.

For banks in Singapore, only two credit bureaus are authorized to obtain such information: Credit Bureau Singapore and Experian Credit Bureau Singapore.

The credit report includes information such as records of all credit checks performed on you, credit repayment trend over the past 12 months, including late payments on credit card bills, records default and bankruptcy records, if any.

A few factors can affect your credit rating:

  • Credit you currently have: the number of open or active accounts that give you a loan
  • Credit history: A long-established record of your ability to repay your debts shows that you are a reliable borrower
  • Application activity: too many new applications or inquiries show that you are trying to take on more debt
  • Recent Credit: If you’ve recently taken out several new loans over a short period of time, you may have overworked yourself.

Until now, I hadn’t realized that investigative activity was a factor that affected a person’s creditworthiness. Indeed, Ms. Tan advised to “only inquire about credit when you need it.”

But Mr. Erik Ligtenberg, Lendela’s chief operating officer, said this was a problem because the interest rates for many personal loans displayed on banks’ websites are usually generic rates.

Borrowers should contact the bank directly to receive a personalized interest rate based on their situation and credit score.

“People end up being ‘punished’ for shopping around and ‘punished’ for comparing different loans when those activities show up on the credit report,” said Ligtenberg, whose company allows users to receive premium rates. custom interest from various banks by submitting a single request on its website.

TIPS FOR FIRST-TIME BORROWERS

1. Be clear about the type of loan you need

“When choosing a loan, it’s important that it is suitable for its purpose,” Ms Tan said.

For example, if you just need a short-term loan to facilitate payments until the next paycheck, a credit card might suffice instead of taking out a personal loan.

On the other hand, for someone who is furthering their education, a student loan may be preferable instead of borrowing by credit card, which has higher interest rates.

2. Pay attention to the effective interest rate

Ms Tan said financial organizations often display the “lowest” rate on their websites, which is usually the (fixed) interest rate charged to attract borrowers.

But Ms Tan suggests looking instead at the effective interest rate (EIR), which takes into consideration the effects of compound interest, which would be “a better gauge that reflects the true cost of borrowing”.

For example, a bank may say that a loan is at 2% interest per annum. But if the interest is compounded monthly, you’ll end up paying a higher interest rate than the nominal 2% interest rate.

3. Take note of additional fees

Borrowers should also take note of other fee payments such as processing fees, late payment fees, and prepayment charges. These are additional charges on top of the interest rate you would have to pay.

4. Have a clear plan on how to repay the loan

“Sound financial planning is essential before applying for a loan,” Ms. Tan insisted.

“Know how much you can afford each month and how that might affect long-term household expenses. This will allow you to avoid the debt trap resulting from spiraling debt that snowballs over time.

Ms. Tan suggested using the “non-mortgage debt service ratio” as a guideline. This is a measure of your ability to repay your debts, excluding housing debt.

It is calculated by dividing the total annual non-mortgage debt payment by the total annual take home pay. A healthy ratio would be 15 percent and less.

5. Set up alerts
It may seem obvious, but setting up calendar reminders to avoid being late on card payments can help avoid late payment fees. Opting for Giro payments, where a fixed amount of money is transferred each month from your bank account to a billing organization, is another option.

“If you have more than one credit card, align the payment date to the same day for easy tracking,” Ms Tan added.

CONSIDER WITH WISDOM

Despite all the advice, Ms Tan urged young people to first think carefully about whether they need a loan “because it comes at a cost”.

Indeed, many friends I spoke to told me that they would only take out a loan as a last resort because they were afraid of interest rates, and that borrowing seemed “dangerous” to them.

A friend of mine added: “I think loans create more inequality because better off people with more assets can get a bigger loan, while less well off people have trouble finding banks. willing to lend them money.

I share the same feelings and only consider taking a loan in case of emergency or if there is no other choice.

But at least I’m not as intimidated by it now that I know what to look out for before committing to one.

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