Taking out a personal loan can be a tempting solution when you find yourself in need of extra funds- especially if you can't get the funds you need from your credit card. However, it is crucial to carefully evaluate whether it is truly the right decision for your financial situation. By taking a step back and considering a few key factors, you can make an informed choice that aligns with your long-term goals.
A few important factors to consider before taking out a loan:
1. Assess the purpose of the loan
Are you planning to use the funds for an emergency expense such as an unexpected medical bill or you looking to make home improvements? Alternatively, is it for something like a vacation or a new item that you've really been wanting? By understanding the purpose, it will help you determine if the loan is truly essential or if there are alternative ways to meet your needs.
These are a few other reasons you may be considering a personal loan:
- You want to consolidate all your debt and instead pay one loan. In this case, the personal loan you may be considering is a debt consolidation loan.
Read: Debt Review vs Debt Consolidation : Which is right for you?
- You don’t have enough money to cover your daily living expenses.
- You don’t have enough money to pay for all your debt.
2. Evaluate your current financial situation
Take a very close look at your income, expenses, and current debts including existing loans. Can you comfortably manage the loan repayments and pay all your bills without compromising your overall financial stability?
It's also important here to consider your current debt-to-income ratio. A debt-to-income ratio is the percentage of your income that goes towards financing your debt.
So, how do you calculate your debt-to-income ratio?
Debt-to-income ratio= Sum of all your debts/ your gross monthly income x 100.
For example: If you earn R17 000 per month and the sum of all your debts is equal to R13 000, this is how you could calculate your debt-to-income ratio:
R13 000/R17 000 x 100 = 76.47%
A good debt-to-income ratio is between 35%-40% or lower. If your debt-to-income ratio is higher than this, you should strongly consider not opting for a personal loan.
3.Consider the interest rates and terms offered by the credit lender
Here you should be cautious of high-interest rates, as they can significantly increase the total loan amount. Additionally, carefully review the loan term and monthly payments to ensure they actually fit within your budget.
4.Reflect on your credit history and score
Lenders typically consider creditworthiness when approving loan applications. If you have a poor credit score, you may face higher interest rates or not even qualify for a personal loan. In such cases, it might be wise to work on improving your credit before applying for a loan.
5.The potential impact on your future financial goals
Taking on additional debt may limit your ability to save for emergencies, invest, or achieve other long-term aspirations. Consider whether the loan aligns with your overall financial plan and if it will take away from your progress towards your desired financial milestones.
Below is a list of 3 reasons you probably shouldn't take out a loan
1.A personal loan can have higher interest rates
A personal loan is usually an unsecured loan which means that, unlike a secured loan, it is not backed by any asset like a car or home. Because of this, banks or credit lenders may see the loan as a higher risk and as such, have a higher interest rate on the loan. In turn, a high interest rate will mean a much higher capital amount you end up paying back.
2.You may be creating more debt than may be manageable
When you take out a personal loan-depending on your reasons for taking it out-you may be just digging yourself into a deeper hole of debt. If you are, for example, taking out a loan to cover your daily living expenses or you’re using it to cover debt that you aren’t able to with your current income.
This can lead to a vicious cycle of borrowing and struggling to make ends meet. It's important to carefully consider the reasons for taking out a personal loan and assess whether it is truly necessary. If you find yourself in a situation where you are constantly relying on loans to cover basic expenses, it may be time to reevaluate your financial situation and seek alternative solutions.
3. It can negatively affect your credit score
When you apply for a personal loan, a credit lender will perform a credit inquiry into your credit report. This will be listed on your credit report as a hard inquiry. If you apply for several loans at several credit-lending institutions and you get rejected for these applications, this can negatively affect your credit score because you are seen as a risk to credit lenders.
Instead of applying for a personal loan, think about your alternatives:
Lastly, explore alternative solutions. Are there other ways to meet your financial needs without resorting to a loan? Can you cut back on expenses, increase your income, or tap into existing savings? Exploring these options can help you avoid unnecessary debt and maintain control over your financial well-being.
1. Create a budget and stick to it
By carefully tracking your income and expenses, you can identify areas where you can cut back and save money. This can help you avoid the need for a loan in the first place.
Read: How to start a budget in 6 simple steps
2. Explore other options for increasing your income
This could include taking on a part-time job or freelancing in your spare time. By increasing your earnings, you can reduce your reliance on loans and improve your financial stability.
3. Consider debt review if you cannot manage your current debt
If you aren't able to manage your current debt or you're struggling to find money to cover your basic living expenses, instead of looking for a personal loan to cover these gaps, you should consider a solution that does not involve taking on more debt.
If you've already looked at your budget and made all the cuts you can possibly make and if you don't have any other options for increasing your income, you should seriously consider debt review.
Debt review is a debt relief process that is regulated by The National Credit Regulator. It is a way for South Africans who are unable to cope with their current debt repayments to get on top of their debt and eventually, after successfully completing the process, become debt-free!
The way it works:
A Debt Counsellor will assess if you are over-indebted and unable to make all your monthly repayments.
They will then put together a new restructured repayment plan that could reduce your monthly debt repayments by up to 50%, giving you breathing room to actually afford your daily living expenses.
Want to know more? Let us contact you about the process!
