Borrowing may be a convenient way to purchase something that you would otherwise take a long time to save up for. In the case of buying a home, for example, a mortgage allows you to live in your home while you pay it off.
Whether you're planning a big purchase like buying a car, getting married or need extra cash to deal with family emergencies or pay for education, sometimes borrowing may not be the best option for you.
Can you afford to borrow?
Before you decide to borrow money, it's worth taking the time to ask yourself a couple of key questions below, and to make sure you can afford new debt repayments on top of your current expenses or commitments.
- What are you borrowing money for?
Taking out a loan to pay for a home or an education makes sense in many cases, but borrowing for vacations or other discretionary items may not be necessary. Too much debt can be a long-term burden.
- Is borrowing your best option?
Borrowing may not always be the best option. There may be other ways to achieve your goals without going into debt. For example, you can meet your goals by saving instead of borrowing
- How much should you borrow?
Everyone's financial situation is different, but you should avoid borrowing more than you can comfortably repay. Before you borrow, ask yourself if you'll be able to make the payments - and remember to take interest charges into account as well. It's usually a good idea to ask your lender for a repayment schedule and a detailed breakdown on the total cost of the loan.
- What is the cost of borrowing money?
When you borrow money, you have to repay the principal (amount borrowed) plus interest. If you choose a floating-rate loan, be mindful that your repayments will rise and fall in line with market interest rates. Be aware that some financial institutions may charge other fees as well, including annual fees and/or handling fees, fees on overdue or missed repayments, early repayment fees, cancellation fees, etc
Before you borrow, consider the following:
- Do a budget to work out your monthly spending, savings and borrowings and check how much you can afford repayments
- Allow for expenses for unexpected events eg losing a job, floating rate loan and emergencies
- Only borrow what you need and what you can comfortably repay. Do not be tempted to borrow more even if you qualify for a bigger amount
- Shop around for interest rates and watch for any extra charges
- Choose the right type of loan that meets your needs
- Make your payments on time to avoid penalties and pay off your debt quickly to minimise total interest payments
- Avoid unnecessary multiple sources of credit to keep an easy track of repayments
Situations when you should avoid borrowing
- Problem paying everyday expenses. If you have trouble paying for daily necessities, borrowing money could put you into debt.
- Covering optional spending. If you can put off an optional purchase until you've saved up the money, you will avoid interest charges altogether.
- Borrowing because to settle other debts. If you're already deep in debt, going further into debt is probably not the best solution.
Risks of borrowing too much
Borrowing too much can leave you struggling financially as you plunge deeper into debt. Be careful about borrowing too much because:
- It draws money from other important needs. If you borrow money, you have to pay interest. Money that goes towards interest payments can't be used for other purposes, such as paying down your mortgage or meeting other obligations.
- Your credit score can suffer if you can't pay your bills. Falling behind on your payments means it will be increasingly difficult to borrow more money for future needs. Find out more about your credit score and how it affects your borrowing.
- It can lead to higher interest payments. Lenders may charge higher interest rates on subsequent loan applications if you are already carrying a large amount of debt.