Taking on debt can be a practical tool to help you purchase a house, car, or establish a business. However, it can become a burden if you don’t carefully manage it, causing you to take on additional loans to pay it off.
In this guide, we’ll provide advice to help you minimise financial risk and make informed decisions when you borrow.
Understand Your Financial Position Before Borrowing
Before considering any loan, take the time to assess your current financial health. List all of your household’s monthly income, including salaries, rental income, and investments, on a spreadsheet. After calculating your total monthly income, include all your monthly outgoings, such as mortgage, transportation, and petrol.
In addition to your income and outgoings, factor in any savings and your existing debt. It will help you determine how much you can afford to repay monthly and the borrowing option that’s most suitable for you.
Explore All Available Borrowing Options
If you decide to borrow money, several options are available to you. Research their terms, interest rates, and risks to choose the right one for you. Unsecured, or personal, loans offer fixed amounts with set monthly repayments over an agreed-upon period. They don’t require collateral and usually have lower interest rates than credit cards, especially if you have good credit. They can help consolidate debt, but may have early repayment fees.
Similarly, secured loans enable you to borrow money and repay it over a predetermined period. The value of the loan is secured against one of your assets, like a car or your home. They allow you to borrow larger sums of money because the lender has more security.
Credit cards are suited for short-term borrowing, providing flexible access to minimum monthly payments; however, they can have high interest rates, especially if repayments are missed. Exceeding your credit limit can also incur fees. Overdrafts in your current account allow you to spend beyond your balance up to a limit, with some interest-free up to a threshold. Keep in mind that unauthorised overdrafts carry steep fees and interest.
Assess the Affordability of Repayments
To ensure borrowing aligns with your ability to repay the money comfortably, look at your monthly budget’s repayment capacity. You’ll want to avoid scenarios that leave you without enough money to meet your essential payments, so make sure you have some breathing room.
While the Financial Conduct Authority (FCA) requires lenders to assess your creditworthiness and affordability, you should also evaluate your finances honestly. Look for online budgeting tools and affordability calculators to test different repayment scenarios, and always leave a buffer in your budget instead of stretching to the limit. If a deal seems too good to be true, it’s best to steer clear of it.
Monitor Your Credit Score and Borrowing Behaviour
Ensure you borrow only what you need, even if you’re eligible for more. While taking on a larger amount to settle your outstanding payments can be tempting, it means paying more interest and making larger repayments.
Smaller loans are easier to repay and will have less impact on your credit score should you encounter difficulties. Download a credit score checking app like Experian or ClearScore to assess the impact of your borrowing on your score and stay informed about your financial standing, as well as what you can do to improve it.
