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What would happen if a bank called you and offered to lend you money at a very low interest rate? If applying was easy and you could have a large amount of money within minutes, would you be tempted to apply?

Banks and financial institutions make it easy for working people to take out loans. Some young people may not even need to borrow money, but are tempted by the loan advertisements. They end up borrowing money and spending it on trendy products, travel or investing on the stock market. Sometimes, they borrow the money without any plan as to how to spend it.

Used sensibly, loans can be very useful. Many people, for instance, take out a mortgage loan when buying their own home. If you borrow money without properly thinking about it, though, this could lead to problems. Some people even end up taking out more and more loans just to pay back earlier borrowing. If you fail to make the payments on these loans on time, you could end up with a poor credit record or even face bankruptcy.

Do I really need a loan?

Before taking out a loan, ask yourself these three key questions:

  1. Why do I need a loan? Is it really necessary?
    When you take out a loan, you not only have to pay back the money you borrow, you also need to pay the interest. You have to think seriously, then, before you borrow money for non-essential things, such as a new phone or a vacation. A $30,000 personal loan, with an interest rate of 15% a year, repayable over two years on a monthly basis (that mean 24 payments), would cost you $4,590 in interest payment. You might also have to pay an annual fee and admin charges. If you didn't take out the loan, you would have no interest to pay.
  2. Is there an alternative to borrowing money?
    Borrowing money is rarely the best option. There are other ways to pay for the things you really want. If you want to go on holiday to Japan, for instance, you could start saving six months earlier, putting aside money until you have enough to cover the cost.
  3. Can you repay the loan?
    Before taking out a loan, work out how much you spend every month and how much you earn. This will show you how much you have left to make a loan repayment. If you don't have spare money, you will find it hard to make repayments.

Bad credit history could affect your career

Both failing to make loan repayments and making late payments will be recorded in your credit history. This could make it difficult for you to get loans or mortgages in the future. A poor credit history will also affect your work life. Many employers in the financial, legal and law enforcement sectors will look at your credit history before deciding to offer you a job or a promotion.

Borrow responsibly

Before you take out a loan, make sure that you understand the difference between what you need and what you want. You also need to know how much money you can afford for loan repayments.

If you really think you need to borrow money, follow these guidelines:

  1. Prepare a budget, listing your monthly expenses, savings and loans in detail. Work out how much you can afford to repay each month before agreeing to any loan.
  2. Borrow only the amount you need.
  3. Borrow only from banks or financial institutions with a good reputation.
  4. Avoid borrowing money from many different banks or loan companies. Too much borrowing will give you a poor credit rating.
  5. Choose a payment term that best suits your circumstances. Repay the loan as soon as possible – the longer you take to pay it back, the more interest you pay.
  6. Compare interest rates and other costs, as well as the terms and conditions, of different lenders. Always use the Annualised Percentage Rate to compare loan costs.
  7. Read all loan contracts carefully and make sure you completely understand them before signing.
  8. Make your repayments on time. If you don't, you may have to pay extra charges.
  9. Don't borrow from companies you don't know anything about. Beware of the risks of borrowing through intermediaries. Some companies encourage people to apply for loans which may charge very high interest rate and fees. If you have doubts about a caller or a company, inform the police.
  10. Protect your personal data. Do not give out information on the phone unless you have verified the identity of the caller and 100% sure how your information will be used.

Use the Annualised Percentage Rate to compare different loans

Interest is the main cost of taking out a loan. Always make sure you understand how this will be worked out before you sign a contract. Depending on the types of loans, there are different commonly used basis on which interest is calculated in the market, eg monthly flat rate or annual rate for personal instalment loans and daily or monthly compound rate for credit card outstanding balance.

As well as interest, there may also be other fees – such as handling fees and annual charges – that you have to pay. You need to consider these fees and the interest before agreeing to a loan.

All financial institutions supervised by the Hong Kong Monetary Authority have to state the Annualised Percentage Rate (APR) of their personal loans and credit cards. This has to be calculated in a way agreed by the banking industry's associations*. The APR should include the basic interest rate, as well as all other annual fees related to a loan. All authorised institutions have to follow the same rules so that loan costs may be easily compared.

* The Hong Kong Association of Banks and The Hong Kong Association of Restricted Licence Banks and Deposit-taking Companies