7 Questions to ask yourself before taking a loan
Credit and loans are available at the click of a button today and it has never been easier to get tempted and make the wrong decision. Easy credit can get you deep into debt before you even realize it. Here are seven questions to ask yourself before you take that loan. These questions will help you assess whether the loan you think you need will help you or hurt you in the long term.
“To be Jedi is to face the truth, and choose. Give off light, or darkness, Padawan. Be a candle, or the night.”
– Yoda in Star Wars
Do I really need it right now?
Most of the time, things are not really needed… at least immediately. Learn to differentiate between needs and wants. While we cannot postpone our needs, we can definitely delay our wants.
You could postpone buying that new phone or vacation by a few months. This can help you to pay more money upfront or even the full amount to buy what you want. You may even save money faster or generate new income since you will be motivated to hit your goal.
Is there a lesser cost item that will satisfy my need?
It is often tempting to buy the top end model but consider if you will use the full features it provides. Is there a less expensive model that will solve your needs? If so, opt for the lesser cost model. Do the research to identify which model and brand suits you.
Will it help me achieve my personal goals?
If your goal is to buy a house or gold or even a trip abroad, how will this new loan impact your plan. In fact, the first thing to do is make sure you have a financial plan. Make your own financial plan today!
If this loan is for an item to meet your goal then it is good. You should however ask yourself if there is any way to reduce the amount of loan that you are seeking using the other questions in this article as a reference.
Can I afford to make the monthly loan payments?
This is again an important question to ask yourself and you need to be honest about it. The total debt should not exceed 35–40% of your net take home salary.
Make sure that you make a budget to understand your payment capability. You should add in your annual payments like insurance etc. to get the true monthly budget. If your payments are very close to the limit of what you can afford to pay then, will your monthly loan payments leave you any flexibility? You might want to catch that movie or buy a new dress that you need.
How long will it take to pay off the loan?
The next question that you need to ask yourself is, how long will it take to pay off your new loan? When you are locked into paying your loans for years, it becomes difficult to plan for the future. It also makes it harder to create financial stability and wealth. The shorter the loan duration, the better it is for you.
Just imagine that you plan to buy a car and take a 2-year loan instead of a 4 year one. Though you might find it difficult to meet monthly expenses, in 2 years you will be loan free instead of taking another 2 years to feel the same amount of freedom. Freedom! I can almost feel it. Consider paying extra where possible to clear loans.
What if I cannot pay?
We must also consider situations where we are unable to make the monthly payments. Always have a Plan-B. Make sure you have a plan in case of any unfortunate instances in your life like loss of a job or other sudden expenses. This is why I suggest that people create a buffer of at least 6 months of expenses to meet emergencies.
Check with your friends or family if they can support you for a short time in case of issues to see if you have some other line of credit which does not depend on your job.
Connect with your lender as soon as possible to discuss option if you are about to default due to some special circumstances. In some cases, they may agree to defer the payments by couple of months for a small fee.
Is this the best deal?
You should do your due diligence and shop for the best deal possible. By this I mean the lowest possible interest rate, processing fees and also good terms of pre-payment, i.e. lesser penalty for repayment and ability to start repayments earlier in the loan cycle.
A bad credit score can increase the interest rate as the bank perceives higher risk in lending to you. Learn about the ways to improve your credit score. If your loan can be delayed by a few months you might be able to improve it and get better interest rates. This is especially important for large ticket items like a house or car. Even a 0.5% difference makes a large impact over 20 years.
Final words
These seven questions to ask yourself before you take that loan are important for your financial health. I hope these questions will help you be more aware of the reasons that you choose to take your loan and plan appropriately. Having lesser loans and a good credit history is key to creating long term wealth and peace of mind.
