You may be the kind of person who hides money under their mattress, who thinks borrowing is diabolical. Yet you have found the man or woman of your dreams and he or she wants to buy a house with you.
On the contrary, you may be the kind of person who is not afraid to borrow money. You have done it before and you will do it again. Only, one of your friend is currently in debt and risks losing his or her assets. You think that perhaps you should be more cautious from now on.
Here are a few tips you should always consider before entering into a borrowing agreement.
Can you afford to borrow?
To borrow is to spend. To borrow is to pay interest rates and perhaps even lose your secured asset. It should not be entered into lightly. Therefore, weigh up whether you could wait and save to avoid the additional costs. You should also consider how much to borrow, since the more you borrow, the more it will cost you.
If you decided to borrow nonetheless, the question arises as to when the best time to do this is. This choice relies on your personal circumstances: whether you have a secure and regular income, or whether there is room in your finances to budget in repayments and interest while still allowing for disposable income in case something unexpected comes up. You may even foresee events that would put a strain on your finances like sickness or a newborn baby.
Finally, whether now is the best time to borrow may also depend on your current credit health. The better your credit health, the more likely you’ll be able to settle a better deal.
Choosing the best deal
Who you decide to borrow from is crucial. You are placing your financial future in that entity’s hands. Firstly, you may like to check whether the body you are borrowing from is registered with ASIC. This will allow you to avoid scams.
Secondly, you will need to shop around for the best deal. This may include comparing the larger commercial banks, but you may also like to have a look at credit unions and building societies as an alternative. There are three main criteria to consider:
1. The interest rate
Choosing the best interest rate is crucial. In the case of large debts, a small percentage change can make a big difference. The interest rate is usually expressed annually; in other words, if your interest rate is 5%, for each $100 that you borrow, you will pay the bank $5.
To compare debt providers is to compare their comparison rate, which is the sum of the interest rate and the fees and charges. For example, the NAB’s comparison rate (5.2%) may be higher than the Commonwealth bank’s interest rate (5%). However, if you include the Commonwealth bank’s fees and charges of 0.5%, the NAB would end up cheaper (5.2%<5.5%).
2. The timeframe
As you plan out your budget for the coming years, consider whether you can accelerate the payback period. By doing so, you may diminish the cost of debt significantly. For example, if you had a debt of $10,000 to pay back over 5 years at 5%, your total interest payment would be $2,500. If you had the same debt at the same rate over 3 years, your total interest payment would be $1,500.
Keep in mind, however, that you need to be able to keep your payments on track at the risk of additional penalties and losing your security. Your budget should be realistic.
3. The terms of the loan
To borrow money, your provider will get you to sign an agreement, often a complicated and lengthy contract. You and your legal advisor should carefully read through the terms of the loan. In particular, look at conditions for early rates (when you pay your debt back faster than expected), and late penalties.
If things go wrong, know who to turn to
You may not think this part applies to you. It does. Things can go pear shaped quite quickly, particularly in the case of unforeseen circumstances. You may not have planned to have a baby or to be made redundant or that your mother would need to go to a nursing home. These are all possible situations that life throws at us that we cannot avoid.
If you are having difficulties with repayments, it is important to acknowledge your situation and act quickly. The first step would be to talk to your debt provider. They will be able to help you and perhaps vary the terms of the agreement. You and your legal advisor should meticulously review the changes. You could also contact a free financial counsellor through community organisations or government agencies.
Consider these three things when borrowing, and you should be able to secure a loan which puts you in a strong financial position.