In the real world, however, many responsible people find themselves needing loans for legitimate reasons. When there is an unplanned financial emergency or an important and necessary purchase, there are some situations in which you cannot avoid taking out a loan. Read on to understand when a new loan is really good.
This may seem obvious, but when people are desperate, they sometimes take out loans with large payments that they could not possibly afford. Before applying for a loan, create a realistic budget that includes payment. If you can’t afford it, you should probably reconsider the loan.
Do not be tempted to tell yourself that you will find a way to make ends meet. Instead, be sure to get realistic additional sources of income before signing on the dotted line. Get a second job, line up your freelance work, start selling things on eBay or do what you need to make the loan repayment affordable. Just do it before getting the loan; otherwise, you are only creating more financial stress for yourself. And isn’t that what the loan is supposed to solve?
Loans are never a good idea when you use them to finance a lifestyle that is beyond your means. However, if you are in a place where you absolutely must have something essential (no, a remodeled kitchen or a tropical vacation is not essential), and you cannot afford it, a loan could be a good idea.
Again, I am talking about basic basics here. If you have to drive to work, you must have a vehicle in operation. If you live in cold weather, you need a working oven. Most of the time, these are not purchases that can wait until you have saved the funds, so a loan might be necessary.
If you have good credit (above 720), you will most likely be eligible for lower interest rates on your loans. This means that you will pay less during the term of the loan and that your individual payments will be lower than they would be if your credit were poorer. And having good credit is, in itself, an indicator that you can probably manage your debt effectively.
Having good credit makes loans much more affordable. But once again, make sure you can make those payments! Otherwise, it will ruin that solid credit score.
Many investors think they should use their investment money to make important purchases before considering a loan. While this is sometimes true, it may also be better financially to leave your investments intact and obtain a loan to cover the purchase. For example, if your portfolio generates annual returns of 10%, but the interest rate of a loan would be only 4%, then it makes no sense to lose that extra 6% in the profits generated by the funds in your portfolio.
If the loan rate is lower than your rate of return and you can make the loan payments, take the loan and keep your money invested. On the other hand, the money in your wallet could be an intelligent source of cash to repay very high interest loans, such as credit cards. However, never touch your emergency fund: that is the money you will need for true emergencies, and unless you face bankruptcy or legal action, high interest debt is not a true emergency that justifies the depletion of your safety net.
Sometimes you know there is money coming in, but you don’t have it yet. If you need to make an important purchase before the money arrives, you can apply for a loan and repay it as soon as the funds reach your bank account.
But if you are taking this approach, make sure your loan has no penalty for prepayment. This strategy may work well for people who get large bonus checks or commission quarterly or annually, as long as they don’t overestimate their real earnings.
There are many “special” loans in the market, most of them offered by different government programs for things like home buying, education or the modernization of energy efficiency. These loans generally offer very favorable repayment terms that often make them worthwhile.
For example, FHA loans, VA loans, and even USDA loans can help people buy homes that they might not otherwise have qualified. My husband and I bought our house last year using his VA loan, which saved us tons of money in the initial costs. Without that, we would have had difficulty paying for the house.
Taking out a loan is something that a financially responsible person may never want to do. However, sometimes loans are necessary to meet our biggest goals and, in the previous cases, they may not be such a bad idea.
What have you bought with money from a loan? Do you think it was worth getting the loan?