Before you borrow money or take out a loan, you want to make sure it’s the right decision for your circumstance. When you take out a loan, you are promising to pay the money back within a set time frame and at a certain interest rate. In addition to thinking about the immediate implications of taking out a loan, you want to consider how it is going to affect you financially in the future. While taking out a loan is tempting, there are a couple of questions you want to ask yourself.
Do I Need to Purchase This Item Right Now?
There are a number of products that seem necessary right now that really are not. Can you postpone making a purchase until you have enough money to purchase it with cash?
For example, it might be inconvenient to take the bus back and forth to work every day. However, you may save money in the long run if you take the bus for a few months while you save up to buy a used car straight out as opposed to getting a loan. And you may save money more quickly than you expected because you feel motivated to make the purchase.
Should I Get a Loan for an Emergency Situation?
No matter how hard you try to plan out your finances, unexpected things happen. A family member may get sick or injured, or you may be forced to tackle an emergency home repair. It is always recommended to tap into your emergency savings account in these cases, but that is not an option for those without savings. In cases like this, you might want to research alternative funding sources like online flex loans from direct lenders, which might help you get out of your financial pinch and back on your feet.
How Much Can You Reasonably Afford to Borrow and Pay Back?
If it is clear that getting a loan is in your best short-term and long-term financial interests, you need to think about how much you can afford to borrow and pay back within the terms of the loan.
The word “afford” means different things to different people. The fact that you can cover a monthly payment doesn’t mean that you can actually afford it. A recent study showed that many Americans live in homes that they cannot afford.
The first thing you need to do is ignore the APR of the loan. This is what banks or other lending institutions use to try to sell you on the loan. What’s more important is the total cost you will pay over the life of the loan. This is the amount of money that you borrow and interest. An easy way to calculate this is to go online and use a loan amortization calculator.
APR can trick you. Look at the following example of two people who borrow $10,000.
• The first person borrows $10,000 with a five percent APR for five years and pays $188.71 per month.
• The second person borrows $10,000 at a six percent APR over three years and pays $304.22 per month.
Which option is better financially? At first glance, it would seem like the first person is getting the best deal. They have a lower APR, and their monthly payments are also lower. However, a closer examination reveals that it’s really the second person who is getting the better deal.
The first person will pay $11,322.74 over the life of the loan. The second person will pay $10,951.88 over the life of the loan. This means that the second person will save $370.86. This doesn’t seem like a lot, but as the amount you borrow increases, the gap gets wider.
Know Your Credit Score
When it comes to taking out a loan, knowledge is power. In addition to knowing what you can realistically afford, figure out what type of loan rate you can qualify for by being familiar with your credit score.
Getting a loan is a big financial step that should not be taken lightly. If you do your due diligence, make sure that you need the loan, and have a concrete plan in place to repay it, getting a loan can be beneficial.