8 questions before you take a loan
These days, every bank, credit provider and micro-lender is offering you money. You receive text messages on your phone, you see ads in the paper or on billboards, and you probably even receive offers in the mail. All this loan marketing comes with a simple message: taking out a loan gives you the financial freedom to do whatever you want, right away.
This sounds like a dream come true, doesn't it? But what these loan providers are not telling you is that this financial freedom is extremely short lived. At the end of the month, your repayments will begin, and you'll find yourself bound by the money you owe. Where's that freedom now?
So, before you leap at the chance to take out a personal loan, here are eight questions you should ask yourself before you sign on the dotted line.
1. Should I be saving rather than borrowing?
The answer to this question is almost always saving. Unless you are buying a car or a house or taking out a loan to finance a (sensible) business opportunity or some form of study or training, it is better to save now and spend later.
2. Am I satisfied that this is an isolated instance of borrowing?
Debt is almost never a good idea, but if you do take out a loan, it should be an exception rather than a financial habit. If you absolutely have to borrow money to get by, make sure that you've made a plan to reduce your expenses and increase your savings, rather than relying on credit to get you through the next rough patch
3. Do I have enough money to pay this loan back every month?
While registered lenders will carry out an affordability test before granting you a loan, it is possible to access credit that you can't afford by being vague or misleading in your responses or by approaching an unscrupulous lender who does not carry out an affordability test. A rule of thumb for affordability is if you are struggling to make ends meet, then you are unlikely to be able to afford the extra costs of servicing a loan.
4. What are the interest rate and fees on this loan?
Remember that you will be charged interest on the amount that you borrow. Your bank will be able to show you how much you will pay back in total, after interest has been added. You should also find out whether the interest rate can increase if the repo rate goes up! Be sure to ask about activation, admin and insurance fees so that you get a very clear idea of how much the loan will really cost you. You should always shop around to be sure that you are getting the best deal on interest and fees.
5. What is the term of the loan?
You may be offered different options for the time it will take you to pay back the loan. It can be appealing to take out the longest loan term because the monthly repayments are cheaper. However, while each month's payment might be cheaper, you will be paying interest for longer, so the total that you pay back will be higher. Always try to pay a loan back in the shortest possible period.
6. Am I borrowing from a scrupulous lender?
Loan sharks or micro-lenders sometimes make it easier for you to borrow from them, however in most instances they charge high interest rates and resort to threatening you if you are unable to make repayments. It is never a good idea to accept their offer. If you must borrow, borrow from a registered and reputable credit provider. If they have turned you down, it's probably because you can't afford the loan and you will only get yourself into trouble if you go through an alternative lender.
7. Is early settlement allowed?
If you find that you have extra cash and can pay your loan back quicker (always a good idea), be sure that you can do this without penalty. Some lenders make an interest calculation based on the term of the loan and don't actually want you to pay back the money earlier, so they will charge you a penalty to do so.
8. If I die, how will my loan be repaid?
If you were to pass away, the lender cannot claim money back from your relatives. However, they can claim the money back from your estate which is the sum of all your assets and cash at the time of your death. This means that the money will have to be found from within your estate to service the debt, which could mean that a house or car would need to be sold, leaving your family with a smaller inheritance. For this reason, if you have dependents and have taken out a loan, it's a good idea to have credit life cover or life insurance in place.
The bottom line
Loans should be isolated incidents of borrowing that deliver some kind of return. You should not borrow money to make ends meet or to afford your monthly expenses. But if you have to take out a personal loan for any reason, be sure that you can afford to pay it back, and that you have understood the interest rate and the other terms and conditions of your loan.
If you have satisfied all these conditions, then take out the loan and pay it back as quickly as you can.