The temptation to borrow money haunts everyone at some point. Sometimes it’s a good idea — necessary, even — but many times it isn’t. Before you take out that loan, you should ask yourself three questions.
Why are you borrowing?
Only borrow out of necessity. This is especially true when it comes to your decision to apply for an easy installment loan or take up credit card debt. These options should only be used for unexpected expenses, like car repairs and home repairs, or buying essential groceries between pay periods.
If you just want something, try to find other ways to finance the purchase. You could put it on layaway, sell some unwanted belongings, or simply save up. The temptation is there to get it now and pay for it later, but you need to understand that if you borrow, you will end up paying substantially more than what you would have originally because of interest.
Money lending is a business, and charging interest is the way that lenders make a profit. No one is going to give you a loan out of the goodness of their heart.
If you want a new house or car, then taking out a loan is usually the only way to do it. You should just make the decision carefully and make sure you can afford the payments.
What are the terms of the loan?
Do not decide to take out a loan based purely on verbal communication with a banker or lender. You must read the terms and conditions carefully.
Interest rates. These can be fixed or variable. That is, they can stay at a certain percentage until the loan is paid back, or they can be subject to adjustment.
Payment schedules. A loan may have a fixed period of time to pay it back. Longer terms usually mean higher interest rates. Credit cards usually have monthly payments.
Secured vs. unsecured. If a loan is secured, that means you have put something that you own — referred to as collateral — up against it. If you don’t pay back the loan, the lender can seize your property. Unsecured loans do not have collateral and make up for this by having higher interest rates.
How will you pay it back?
It’s important that you never get a loan you can’t make the payments on. You should also think about what your financial situation will be in the future. Are you worried that you might lose your job? Are there medical expenses coming up? If so, it might be better to put off borrowing until you are in a more stable position.
You should give yourself some wiggle room. Interest rates can, and do, rise. This means you could end up paying more each period than you initially agreed to.
Remember that late payments will hurt your credit score. A very bad credit score will make it hard to take out loans in the future. It can make it almost impossible to buy a house, a car, or get on a lease for an apartment.
How to Avoid Burdensome Debt
The real killer with debt is the interest. Hence, the best way to avoid being swallowed by debt (behind not borrowing at all) is to avoid interest by paying everything off as soon as possible.
For example, you can still use your credit card as long as you completely pay the balance off every month. In fact, this is a great way to build credit in the beginning.
For other types of loans, putting more money down, paying above the minimum payments, and choosing the best available loans will save you in the long run.
* Thanks to site supporters for this post.