Whether it’s to pay for your education, buy a new car, or pay for an unexpected bill, a reliable source of credit is an important financial tool for many of us.
However, without proper financial management it’s easy for debts to build up and to quickly feel overwhelmed by your financial situation. That’s why, before you take out any loan or borrow any money – whether from your family or a bank – you should take a moment to stop and ask yourself these five important questions.
1.Is this necessary?
Always start with this question. It may seem self-explanatory, but you may find that by taking the time to ask it you truly weigh up the difference between want and need.
If the answer comes back “yes”, it is necessary, ask yourself if it is something that you need immediately, or if it’s something that can be bought at a later date when you have had more time to adequately plan around it.
2. How much are the repayments?
If you go ahead and decide to borrow the money, be very clear about how much the repayments will be. Some plans have varying repayment rates, whilst others will penalise you for missed repayments, adding extra costs onto your monthly rates.
Once you know how much the repayments will be then make sure you take an honest look at your budget to make sure you can really afford it without compromising your standard of living or your savings and investment goals. You should always aim to keep your debt to income ratio as low as possible.
3. How long will I be paying this loan off?
Some loans appear to have fantastic monthly repayments that are affordable and well within your budget, however, it may be because the loan is spread over a considerable period of time. Ask yourself if you really want to be paying for your new TV three years down the line, and if you can even make that sort of financial commitment so far into the future.
If your financial situation changes – such as losing your job or going on maternity leave – will you still be able to make these repayments as scheduled?
4. What is the interest rate?
This is another important point of consideration. Almost all loans come with an interest rate. This means that by the time you have finished paying them off you will have paid back more than you borrowed. Take time to look at the interest rate and ascertain whether is it adjustable or fixed, and shop around to make sure it is fair or that a better deal isn’t available elsewhere.
If you are buying a product with a repayment plan – like a dishwasher – then take a moment to think if it is worth paying the interest on it, or if you can afford to wait a few months and save up enough money to buy it outright, thereby saving yourself money in the long run.
5. What are the consequences of a failure to repay?
This is important especially for larger loans. Always ask yourself what the consequences are for a failure to repay. Will there be large scale consequences such as vehicle or property repossession, or will you be left with a mounting debt that you will never be able to pay off?
Keep in mind that with a poor credit history you may have a difficult time securing credit in the future, which can be problematic if you want to buy a house, or even if you want to renew your car insurance or change internet or utility providers.