Borrowing money is a huge responsibility. Find out why people borrow, and what to consider before you do.
- Only borrow what you can afford to repay, no matter what happens.
- Always ask for a schedule of payments and read the small print.
When should you take a loan?
Apart from borrowing to make big ticket purchases, people also borrow for other reasons. These fall into 2 broad buckets:
- Unavoidable events such as emergencies, medical needs or sudden loss of income
- Avoidable events such as overspending, impulse buying, and unnecessary expenses
Take a moment to think about why you're borrowing. If you are borrowing mostly for avoidable events, it's time to take stock.
Before you take a loan
Borrowing money is a huge responsibility. Before you commit to borrowing, ask yourself these questions:
How much do you really need to borrow?
Only borrow what you're sure you can repay, even if you qualify for a larger loan. Ask yourself: do I need it? Should I save for it first? Can I afford the repayments on top of all my other loans and expenses?
How are you going to repay the loan?
All loan repayments must be made in full and on time, even if your circumstances change. If your salary gets cut, you lose your job, or your spouse stops working, are you still able to repay your loan?
To get a realistic picture of your ability to pay, you should take stock of your current finances:
- See how much you have left after setting aside some savings and paying your monthly expenses, including existing loans.
- Set aside an emergency fund. Have enough savings of about 3 to 6 times your monthly expenses, in case anything happens.
- Build in some buffer. Take into consideration that your expenses could increase over time.
Can you afford the repayments?
Ask for a repayment schedule to get an idea of the total borrowing costs (including total interest payable) before you borrow. As always, read the small print. You should think about:
- Fluctuating interest rates – Interest rates can go up. Even small increases can make a big difference in the total amount you pay, especially for floating rate loans.
- Loan tenure – A longer term loan costs more. For the same amount borrowed, the total interest payable for a longer term loan will be more than that for a shorter term loan.
- Affordability – Think about your ability to meet the monthly repayment when choosing the loan tenure.
Can you take on a shorter loan?
A shorter loan term means you save on interest payments, even for the same loan amount and interest rate.
For example, for a $50,000 car loan at 6% interest a year, here's how much you could save by opting for a 5- or 6-year car loan versus a 7-year loan:
| Loan | 7-year loan | 6-year loan | 5-year loan |
|---|---|---|---|
| Number of payments (A) | 84 | 72 | 60 |
| Monthly payment (B) | $731 | $829 | $967 |
| Total payments (A) x (B) | $61,404 | $59,688 | $58,020 |
| Interest saved versus a 7-year loan | - |
$1,716 (i.e. $61,404 – $59,688) |
$3,384 (i.e. $61,404 – $58,020) |
After you borrow
You should:
- Make your repayments on time and in full to avoid any penalties or additional interest
- Repay part or all of the loan early if you have spare cash, e.g. bonus or salary increment — but check if there are pre-payment penalties
- Review your debts regularly
- Avoid having too many different loans as it can be difficult to track
