Life happens. You can be going through life, doing everything right – saving 20% of your paycheck for a rainy-day emergency, only purchasing what you need. Then something happens to throw you into a tailspin. You lose your job, your car breaks down, you have a health scare, and all that you have managed to save is gone in an instant, and you’re still short. What are you supposed to do?
If you find yourself in the position where you need to borrow money and are afraid of sliding into debt because of it, it doesn’t have to be a fearful situation. Knowing how to borrow responsibly and within your means can make a huge difference in your financial standing and actually boost your borrowing abilities in the future, should the need arise again. There are many reputable companies available to borrow from. Some are governed by banks, lending companies, payday loan companies, even Indian tribes offer loans such as WithU. Who you choose is completely up to you.
Is Borrowing a Priority Right Now
One of the first things you need to do is ask yourself is this something I need immediately or is it something you can save towards obtaining? For instance, if you need your car to get back and forth to work and it’s inoperable – that would be a priority if you didn’t have public transportation you could rely on. However, if you are borrowing money just to purchase new furniture or to take a trip somewhere that isn’t necessary, that would not be responsible borrowing. Ask yourself these three questions:
- Do I honestly need what I am borrowing money to purchase?
- Is the purchase worth the interest I will have to pay on the loan?
- Will not making this purchase negatively impact me a week, month, year from now?
If you answered no to any of these questions, then you are not responsibly borrowing and should forgo adding the extra debt to your budget. This brings us to our next point.
Review Your Budget Before Applying for a Loan
Before you even head to the bank to request a loan for your emergency need, you need to sit down and ask yourself what you can realistically afford to pay each month. You don’t want to walk into a bank and be told your monthly payment is going to be $300 a month when you can only pay $150 a month realistically.
Now is the time to take a hard look at your fixed expenses and fluctuating expenses. Divide your income among needs, wants, and savings/debt repayment, using the 50/30/20 budget.
50% of your income for needs, 30% of your income for wants, and 20% of your income to savings and debt repayment. You can find a great calculator that will help you break down what you should set aside for each category from your take-home salary. There are many apps that you can use as well to help you with your budget. One of our favorites is Mint – available on Google Play and the App Store.
Be Realistic and Only Borrow What You Need
You walk into a bank looking to borrow $3,000 and the loan officer says you qualify for $10,000. That lure of “easy money” does a lot of people in. This isn’t free money, you will have to pay it back, with interest. The more you borrow, the longer it takes to repay, the more interest you will pay. Your credit score is extremely important as to the amount of interest you will pay as well. So for the purposes of this article, we’re going to use calculations for someone with a “needs work” credit score (650 or less). As of this writing, individuals with a “needs work” credit rating receive interest rates between 18% and 35%. We’re going midway with a 25% interest rate.
Example A – $3,000 Loan
Example B – $10,000 Loan
As you can see, borrowing in excess of what you truly need is going to not only raise your monthly payments, but you will be paying more in interest over the same period of time. While most people may be able to afford a $285.13 payment each month, very few will be able to pay the $950.14 per month.
Now granted, you can lower your payment amount by setting your payment term to 18 months or even 24 months. The only downfall with that is you will pay much more in interest.
In Example A if you extend your loan repayment of $3,000 to 24 months, you will pay a total of $3,842.75 ($842.95 in interest) with payments being $160.11 per month.
In Example B if you extend your loan repayment of $10,000 to 24 months, you will pay a total of $12,809.16 ($2,809.16 in interest) with payments being $533.72 per month.
Make Your Payments On Time Every Month
What happens if you cannot make a monthly loan payment on time? You incur late fees. This fee can be flat or assessed as a percentage of the payment, depending on the lender. So it is only natural to assume that a late fee on the $10,000 loan will be considerably more than on the $3,000 loan. It also will not help your credit rating to show that your payments were late and could hinder your chance to obtain another loan in the future should you need to.
Making timely payments and only borrowing what you absolutely need shows lenders that you are a responsible borrower and could potentially increase your credit limit with the loan institution when it comes time for more important loans, such as buying your first home. Do your research and find a lender that will work for you and your budget. Borrowers who make their payments on time, every month, are responsible borrowers that lenders can trust. In this world, trust is everything.