Five Questions to Ask Ourselves Before Taking Out a Personal Loan

Ideally we shouldn’t! At the same time many amongst us need a little help with our cash flow from time to time or to get the big stuff in life – houses, for instance. Similarly, as somebody said in a conversation recently, ‘one man’s credit is another man’s job’. Yes, this is another way to say that lending is in effect the main business of any bank – and a very profitable one. Before anyone starts ‘banks’ bashing’ – or even thinking about starting – let us remember that the very early banks, in fact banks before banks, had two main functions: lending and making it easier to transport wealth. Usually these were separated and moving wealth around was in the hands of an already existing institution (the Knights Templar are an example of that).

Enough history for now. The point I would like to make here is that we all need loans from time to time and that there are plenty of possibilities when it comes to lending and borrowing. Which also means that to borrow responsibly and beneficially we need to ask ourselves some questions at the start.

Why a loan?

You probably noticed that I said ‘need a personal loan from time to time’! yes, I believe that responsible borrowing hangs on what we consider to be a need in this context. this has two aspects to it: a) what are you going to use the loan for; and b) can it wait. Obviously the answers will be very different in different circumstances.

For instance, you don’t need a personal loan to go to your dream holiday to …fill in the blank. Trust me on this one – borrowing for holidays, designer shoes or jewellery is a sign of an inflated idea of what life is about and of problematic money management; this is likely to end badly and you will get in debt. Thinking about it, you may already be in debt. Holidays are necessary but they can wait – don’t borrow, save the money!

It is entirely different situation if you are borrowing to buy a house; or for that matter, if you are already in such trouble that a personal loan from a reputable source is the only way out.

I would say that here the general rule of my friends from Control You Cash applies: borrow to buy assets; never borrow to buy liabilities.

Where a loan?

In our credit obsessed societies the possibilities when it comes to getting a personal loan are plentiful. Here choice will depend on personal situation and culture. There are still cultures where the social relationships are still fairly informal and most borrowing occurs within family and kinship groups. In most industrial societies, however, borrowing involves specialised institutions – banks, building societies, short term loans companies and more recently peer-to-peer lending arrangements.

It is important to select the source of the loan carefully and base this decision on information and cold hearted analysis rather than ignorance and prejudice. So do your homework!

 How are you going to repay the loan?

This is probably the most important question of them all: deciding to borrow money is the easy part in all this, borrowing responsibly is the hard bit.

Responsible borrowing demands that before enacting it you have complete information and an honest assessment of your financial situation. Don’t estimate, don’t hope, don’t kid yourself! This will make the difference between using a personal loan as a useful financial instrument or as a vehicle for financial destruction and lifetime of unhappiness and deprivation.

Don’t guess, hope and pray!

Research, think and plan!

What is the interest?

This seems pretty obvious but many people don’t pay much attention so decided to include it. The rate of interest you pay on a loan can make immense different to how much you repay and how fast you can repay it. In simple terms, the rate of interest will make all the difference between ‘two steps forward, one back’ and ‘one step forward, two back’.

Generally, but not always, the lower the interest the better. High interest is acceptable if you intend to pay the personal loan back before interest is charged.

Have you read the small print?

I know, I know…This is boring and it may need new glasses. I feel the same!

But as you may have already guessed, feelings are not really the way to go when it comes to deciding to take out a personal loan. So snap out of it, get a magnifying glass and read the small print.

Ensure that there are no clauses that lock you into things that you don’t want to be locked in. Particularly important I find is to ensure that there are no penalty clauses for early repayment. Yes, I am aware that sometimes when people take out a loan they don’t believe they will be able to repay it early but you may be surprised; very pleasantly so.

I believe that these are the important questions to ask before taking out a personal loan. What do you think?

6 thoughts on “Five Questions to Ask Ourselves Before Taking Out a Personal Loan”

  1. My main question when I take a loan is “will I generate more wealth than what I will repay”. I can be wrong in my calculations and life can happen but if I don’t think I can make back the money when selling my house I shouldn’t take a home improvement loan, etc. For anything else that will depreciate, like a car, I’d rather wait and save the money. And fortunately, I have never had to take a loan to eat.

    1. This does make the assumption that you are borrowing the money to improve the value or that you ever plan on selling it (especially in a time frame where it is possible to separate the signals of value of the addition vs value of the original structure).
      If you are building an addition because your family is growing and you don’t want to move, then the decision is no longer a financial one. And I have a friend whose sister now lives in the house where they were raised and their mother was raised before that. Their grandfather never made any calculations about future home values when he built it, nor did their father when he had the extra wing added.

  2. The key to most ‘ordinary’ folk is “How are you going to repay the loan?”

     Interest rates can be confusing but “How are you going to repay the loan?”

     That is probably the key.

  3. We cannot avoid that there comes a time that we need to borrow money.  We should be practical and need careful planning in doing this. Plan carefully on how will you pay this and what are the resources for you to be able this loan.

  4. Borrowing isn’t always bad if it is for a practical purpose, and as you said know how you’re going to pay the loan back before taking one out. It may be ideal to save cash to buy a house or a car, but in the real world it’s rarely doable for the average person.

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