Any time you borrow money, you put your finances at risk. And in many cases borrowing money isn’t the most sensible thing to do (there are times, however, when leveraging a loan does make sense. For example, taking out a mortgage to buy property that increases in value, getting a student loan to pay for education that will increase your earning potential and taking out a loan to grow a profitable company.)
So, how do you know if borrowing money is the right thing for you? There are distinctions between “good debt” and “bad debt,” but the biggest factor is whether you manage whatever you borrow effectively.
Here are some simple, and essential, dos and dont’s of borrowing.
KEEP IN MIND THAT BORROWED MONEY COMES WITH FEES
Always be prepared to repay more than the amount you borrowed. Lenders base their fees on a number of factors, with the main ones being the borrower’s credit history, loan amount and term.
DON'T BORROW MORE THAN YOU CAN AFFORD TO REPAY
This one of the main reasons why some people spend their entire lives in debt. When estimating the loan amount, also consider its annual percentage rate (APR) and its influence on monthly payments. Choose a sum of money that you can afford to repay and don’t exceed it.
DON'T EXTEND LOANS TOO FAR AHEAD
A frequent mistake is to focus on monthly payments. Too often, people ignore the fact they must pay those installments for years.
Sometimes, your debts are so high, it takes years to pay off everything. Set aside a certain amount each payday for an emergency fund. Ideally, your savings should cover expenses for about six months. The only way to prevent or eliminate debt or save money is to spend less than you earn.
RESEARCH RATES AND FEES
If you do need a loan to get through a rough patch, look at the details. The loan principal may come with a low APR but include a bunch of extra fees that make the loan cumbersome — making a small loan much larger.
DON'T BORROW MONEY UNLESS YOU HAVE TO
Before you sign up for a credit card or bank loan — or add to an existing card or loan — it makes sense to think about whether you really need to borrow money. Your aim should be to use the good debt, for example home, educational and small business loans, only when it is appropriate.
READ ALL DOCUMENTS THOROUGHLY BEFORE YOU SIGN THEM
Too often, people are so eager to get the money, they skip the reading part and jump to the signing part. This too often leaves them trapped in terms and conditions they didn’t expect because they chose not to read what they agreed to. A loan agreement may come with surprising terms. Read everything! And if you find it difficult to learn all those terms, hire somebody specialized for help.
PAY YOUR LOANS ON TIME
If you’re one of the hundreds of millions of Americans struggling to climb out of debt, you may be tempted to ignore your bills. But if you’re not able to make a payment on time, the best course of action is to reach out and be proactive. When contacting a creditor, mention you might miss a payment and why, and ask if there’s anything you can do to avoid having it show up on your credit report.
Being proactive can pay off because creditors are more likely to work with you if you start communicating early. And many creditors have policies to help borrowers who are worried about falling behind.