At some time in our lives, most of us will need to borrow money. Whether to pursue higher education, purchase a home or a car, or start a business, there are times where you simply won’t have enough cash flow to fund a purchase without taking on debt. When a loan helps you to better your financial future, it’s an investment in your future that makes sense.
As such, borrowing is not a bad thing. It allows you to pursue life goals, and can also help boost your credit rating. With a responsibly financial plan and spending habits, debt can help you to achieve life goals.
When borrowed money is mismanaged, however, it can lead to growing debt and wreak havoc on your finances. We borrow money in numerous ways, from credit cards, to lines of credit, to loans and financing purchases. Consider the following five questions before you decide to go ahead and borrow money.
How much can I afford to borrow?
Before taking on a loan, look at the big picture and don’t take on more debt than you can afford. It’s important to know how much your monthly payments will be to make sure you can cover them. There are numerous loan payment calculators online like this one to help you get an idea of what your loan payments might be. Your lender likely has one also.
Take a look at your monthly budget and see how much you can dedicate to the loan payment, without taking money away from other areas such as savings, routine bills and day-to-day necessities. Consider your gross debt service ratio (GDSR). This is the percentage of your gross monthly income that you need to pay for basic housing costs. If it’s higher than 32 percent, you may find it difficult to cover other expenses.
Is it good debt or bad debt?
Debt is considered good when it is an investment that gains value over time and improves your quality of life. Mortgages and student loans are generally considered good debt. The former is seen as an appreciating asset that will make you wealthier in the future. The later can help you increase your earning power and future net worth.
Debt is considered bad when it involves money spent on goods that are consumed over time and provide no return. It’s used to buy something that depreciates in value or that you can’t repay on time and in full, incurring interest charges and more debt. Credit cards and payday loans are considered bad debt. Credit cards are perceived as bad debt because they are often used to purchase items that are consumed right away or that start losing value; they also tend to carry high interest rates. Payday loans are usually short term with extremely high interest rates and high fees.
How long do I have to pay it off?
The loan term is the length of time you have to repay the money you borrow. This will depend on how much you borrow and the type of loan. A larger loan amount might have a loan term of 60 months, for example. You will pay interest for the duration, which mean the longer the term of the loan the more interest you will pay. When selecting a loan, also inquire about any penalties. Some loans charge fees for making extra payments or repaying the loan early, so it’s important to know your options.
Note the difference between an unsecured and a secured loan. While a secured loan generally offers a lower rate, if you don’t pay it back you may end up losing the item you used to secure the loan, such as your home or car. Mortgages and car loans are the most common examples of secured loans. Credit cards, student loans, and personal loans are the most common unsecured loans.
How much will it cost me when interest is factored in?
Consider that you will actually be repaying the amount of the loan plus the interest. It’s a good idea to calculate how much interest you will pay over the term of the loan so you know the true cost; you can always ask your lender. A low interest rate and longer term are easier to manage but keep in mind this will cost more over time when interest is factored in. Also, if the interest rate is fixed for the term of the loan, it is fairly straightforward to figure out. If it varies with Bank of Canada rate changes, such of home equity lines of credit (HELOCs) do, it may change with changing rates.
Is this the best deal?
Don’t presume to just accept the first loan you come across. We shop around for many things, whether it is a new TV, new car or vacation package, so the same should hold true for financial needs. Kerri-Lynn McAllister, chief marketing officer with RateHub.ca, notes that, “A lot of people are loyal to their banks and they shouldn’t be, they should be shopping around. They’re leaving sometimes thousands of dollars on the table.”
Visit sites such as RateHub.ca and RateSupermarket.ca to compare credit cards, loans and bank accounts. Ask around, call different lenders, and see what the best rate you can lock in is. It may seem like work initially, but it can save you money in the long run. Making smart financial choices today on borrowed money you will be repaying for years will help you to stay on track financially.
If you are dealing with overwhelming debt, you don’t have to go through it alone. Contact 4 Pillars Debt Consultants of Newfoundland today. One of our highly trained debt relief specialists will work with you to find the best solution for your personal situation, and get you back on track to debt-free living.
If you have concerns about your debt or if you’d like to discuss your debt restructuring options, call us today, Christine Wagner and Paula Ryan of 4 Pillars St. John’s, (709) 700-5509.
Robert’s situation was unique to him and his family, as your debt is unique to you. But with the help of 4 Pillars you can write your own rags to riches story, complete with the happy ending of your choosing. For Robert and his wife that happy ending will be a stress free, comfortable retirement… and maybe a boat!
To learn more about 4 Pillars Debt Solutions. Visit us at 4Pillars.ca. And don’t forget to sign up for our Debt Bootcamp.