By Charlestien Harris
Financial literacy is an important topic, and I want to expand the knowledge of the consumer by explaining the process of borrowing money and the key factors you should consider before you decide to borrow. Knowing how to properly borrow money is a very important step when making a major purchase such as a house or car. There is more to borrowing money than just finding a lender, taking the loan, and then signing on the dotted line.
You should consider the following “rules” when borrowing money:
- If you can, try to avoid borrowing from family or friends. Friends and family members may be some of the people we trust the most, but unpaid debt can damage relationships, sometimes irreparably. If you’re concerned about your ability to repay the money, it may be best to steer clear of this kind of arrangement. Lending money to family and friends can be a gesture of goodwill when someone you know is in a financially difficult spot, but it can become an issue of epic proportions if your efforts to help lead to disagreements or you experience financial issues as a result.
- You should ask yourself if you really need to apply for a loan in the first place. You never want to borrow money just to borrow money. You should have a clear idea of why you need the money. You may be able to provide the money you need by making some adjustments to your budget or maybe consider using a portion of your savings. If you can’t do that, then you may want to find out if you qualify for a loan. Lenders will want to see the following:
• Proof of stable income
• Acceptable credit history
• Adequate savings
Having this information readily available will help speed up the process of borrowing money. Knowing your credit score or what you will use for collateral (if needed) will also help. Having some money set aside in a savings account or an item of value to use as collateral will show that you have given some thought as to how you would pay the money back if you had an emergency arise.
- Ask yourself: What is it costing me to borrow this money? Understanding the cost of borrowing money is vital to the process and that knowledge can help you to stay on track financially, especially if you are living on a budget. It doesn’t matter if you’re borrowing from a bank or using a credit card, you should learn about the difference between APR (Annual Percentage Rate) and interest rates as well as what other factors can affect the personal loan rates you receive. This will help you better understand how much you’re paying in interest over the life of the loan, or, to be honest, how much it will cost you to borrow the money. On the other hand, you might want to think about how borrowing this money will increase your debt-to-income ratio, which may hamper your borrowing power in the future. It may also limit your cash on hand and your ability to respond to other financial obligations.
- You should know the terms of the loan. How long will I need to borrow this money is a question you need to ask yourself as well. The loan term is defined as the length of time scheduled for repaying the principal and interest. Don’t assume that every bank will offer the same payment terms. Shop around based on interest rate, available terms, customer service, and trustworthiness of the lender. Loan terms may differ widely according to the type of loan. Personal loans generally are short term and can stretch between one and five years. Mortgage terms may last up to 30 years. Terms for car loans are usually five to seven years or less. You may also want to know what happens if you decide to pay your loan off early. Sometimes an early payoff means paying a penalty to do so. Always read the fine print, ask your lender questions, and never sign documents you don’t understand or don’t agree with the terms. Just because you qualify to borrow a certain amount of money doesn’t mean you have to. Only borrow what you need.
- Try to create a plan to pay the money back BEFORE you borrow. Having a payback plan in place can lessen your chance of defaulting on the loan. Prioritizing your most important needs ahead of time should help you get the most out of the money you borrow because it is already included in your regular monthly budget. The faster you can pay off a loan, the less it will cost you in interest. Planning how you are going to pay the money back can lower your total cost of borrowing and save considerable money in interest payments alone. If you fail to plan, you plan to fail is the mantra you want to consider when it comes to your financial health.
Borrowing money doesn’t have to be a difficult task. Before dashing off to put your signature on a loan, consider the many ways borrowing will affect your finances. While it is true that financing can help you to achieve your goals much faster, you should never assume that all loans are the same. Every bank or lender’s loan procedures are different, so do your research and shop around for the best terms. This assumption could lead you toward the wrong product and/or paying more in interest than necessary. Unless you’re borrowing money for one specific need, you should consider prioritizing your spending. Knowing the pros and cons of all your borrowing options will allow you to make an informed and confident decision.
Until next week – stay financially fit!