Being financially educated can help us come to smarter decisions when it comes to our money. Borrowing money from others like lenders, banks or family members is sometimes a decision we have to make when in need of extra financial support. There are certain things to keep in mind before doing so to ensure that we avoid debt.
HOW DOES BORROWING WORK?
Some financial situations need to be supplemented with money from another source. This can be from a bank, a financial services provider, or an independent lender. Buying a car or home and tertiary education are examples of why we might need to borrow money. Lenders do not only lend you money but also receive money from loans. This means that lenders do expect value in return. So be sure to research and fully understand how loans work. A few key terms to understand are:
- Principle: This is the amount you borrow from the lender and the amount you need to pay back.
- Loan term: This is the period that the loan lasts and it needs to be paid by the time the term is up. Different types of loans have various lengths of loan terms.
- Interest rates: The interest is a percentage of your loan the lender charges on top of the principal amount. This amount can differ according to your risk level as well as between fixed and variable rates. Fixed rates are set according to the loan amount whereas variable rates can increase or decrease from month to month.
Be prepared for the loan application process by making sure you have all your finances in order and that your credit history is in good standing.
The decision to borrow or take out a loan should not be made hastily, as its effects could have a lasting negative outcome in the form of bad debt. Consider the following before you think about taking a loan out and read our ultimate loan guide here.
Do you need to borrow money right now?
Assess your need to borrow money and the reason why you need a loan. Will it positively add to your life in terms of reaching a goal or is it for something that you can do without? And are there other ways to achieve this goal without borrowing money?
Are you financially secure enough to borrow
Do not borrow when you are already in debt as it can make it even harder to recover from. If your debt-to-income ratio (which compares your monthly income to your monthly repayments) is over 50% reconsider taking on more debt until you have enough disposable income to do so.
Avoid variable interest rates
Variable interest rates increase and decrease per month which can affect how much your repayments are. Avoid variable rates when taking out a car, home, or student loan as it will make it harder to budget for how much you will be paying overtime.
Budget, budget, budget
Planning for the financial impact of a loan is important. Most loan repayment terms can last a few years and in those years your income might change. Make sure that you have enough saved away for other fees associated with loans such as late-payment or initiation fees. Read more on how to pay off loans faster and smarter here.
Compare before you commit
Lenders such as banks and credit institutions offer various loans that differ in terms of interest rates, loan terms, or other conditions. Compare different loans to you and choose one with a manageable repayment amount, allowing you to keep on saving every month.
ADVANTAGES & DISADVANTAGES OF BORROWING
Borrowing money might be the one extra financial push we need in life to help us succeed, whether it be in business, education, or supporting your family. If the loan is managed properly, and debt is avoided, there would only be a positive outcome; buying your first family home or preparing for the birth of a child, etc. Loans and borrowing money can also help build a good credit score. However, missing payments or not paying the loan back in time can damage your credit score and leave you with a debt larger than the principal amount to pay back.
When considering borrowing money, make sure that you are fully educated on how they work and the best way to manage them. Ensuring that they function as a financial tool to help increase or sustain your standard of living.