The basics of borrowing: A guide on loans

Taking out a loan is a very big decision! For the foreseeable future, you are burdening your finances even further than they currently are, and while our repayments will be a constant, everything else around you will begin to change.

You might get married and start a family right at the beginning of your 5-year car repayment plan and a new family could mean a new house. Before you know it, your finances (or lack thereof) could start stressing you out. Which could mean borrowing some money.

If you’re going to borrow money, then you need to do it with some degree of tact and prudence, taking all relevant factors into account. One can’t avoid borrowing money in today’s economic framework as a mortgage is almost necessary to buy a home, college is too expensive to get through without a student loan, and cars lose resale value if they’re not purchased using a payment plan. Regardless of such need, one can make their life easier by borrowing smart.

What situations warrant borrowing of money?

Finances are a very tricky area of our lives to navigate. Pure prudency would dictate that one only purchase using funds that are already available in savings rather than borrow money for the same. However, the problem with this strategy is that it limits our spending power and adversely affects our financial growth. In today’s economic climate buying a house or a car is almost impossible without some form of financing.

This approach does not mean one use credit to purchase a new TV or landscape their garden, but there are certain situations where one needs to, and frankly should, consider borrowing money, in order to improve their own financial standing and advance in life. Student loans are always justified if one truly wants to improve their lives through education and start a career. If you are borrowing money to enable yourself to make more money, then the borrowing is justified.

Then there are situations where you are borrowing money because there is more value for money in doing so. In July 2019 the average price of a house in the United Kingdom was £232,710. It would take a person VERY long to save that amount of money all while paying rent and utilities, raising a family, making car payments, etc. Borrowing money to buy a house is smarter as, instead of paying rent, you could use that money to make your mortgage payments.

With rent, you’re virtually giving money away as the property is still not owned by you and you can stay there only as long as you keep paying. With a mortgage, you’re paying towards owning the house and, once the payment schedule is complete, you own an asset.

You can also borrow money in order to protect your finances. One example is purchasing a car, as vehicles depreciate in value and it makes more sense to buy a car using financing for this reason. With today’s vehicle industry practices, if your car is on financing, it’s even easier to switch to a newer model as the financing plan shifts over to the new vehicle. If you had paid in full, you would first have to bear the burden of selling at a depreciated value and then paying more on top for a newer model.

However, sometimes borrowing money becomes more of a necessity than anything else. Unexpected medical bills, debt reconsolidation, business failure or some other financial crisis could move anyone to have to borrow money in an emergency. The only rule one should follow is that every factor should be taken into consideration before you decide on applying for a loan.

How important is my credit score?

When a lender is considering extending a loan to anybody, they ask themselves several questions. Does the borrower have a steady income and savings? Does the borrower’s salary allow them enough room to make the projected payments every month? Does the borrower have any existing outstanding loans and have they been making their payments on time? While all these factors are looked at individually and in detail, your credit score is a numeric and consolidated representation of all of these factors.

The higher your credit score is, the more favorable you look to the lender as you are at a lower risk of non-payment of dues. A higher credit score will mean lower interest rates, which saves you thousands of pounds in repayment (as explained below), and more options in the types of loans available to you with fewer restrictions and conditions in place. There are lenders like Everyday Loans that will still extend loans even if you have a less than perfect credit score, but maintaining a healthy credit score is nonetheless vital to the process.

If you have a bad credit score, then there are measures you can take to improve it, which you should do especially if you consider borrowing money. There are even smartphone apps now that can help you keep track and will even suggest what kind of accounts you can open or investments you can make that would improve your credit score.

How important are interest rates?

In simple terms, interest is what you’re paying for availing the facility of borrowing money. It is the profit that lenders make on extending their own money to you so you can make your purchases and improve your lives. The higher your interest rate is, the more money you will be paying back to the lender. If you’re borrowing £10,000 at 10% interest, then you’ll be paying back £11,000 in total.

If you’re opting for a longer-term loan, then the interest has a longer time to accrue, but the rates still stand and you’re paying back the same amount of money you would in a short term loan. Therefore, its important you keep an eye on interest rates and how they are structured over long term loans to ensure you aren’t paying an insane amount of money on top of what you’ve borrowed.