Can You Afford a Personal Loan?
While personal loans are an attractive option to get the money we need to buy what we want, the idea of borrowing money can raise a lot of questions, like “Should I get a personal loan?” and “How much loan can I afford?” If you find yourself asking these questions, you should know that it’s normal to be hesitant about taking out a personal loan, especially if you aren’t sure what it’s going to cost you to do so.
Many first-time borrowers are unsure of how much personal loans are going to cost and whether they are a good fit for their financial needs. After all, personal loans come with fees, interest and late charges, among other things, and all of those factors have to be weighed to decide if this type of loan is right for you.
Personal loan costs
Borrowing money is a luxury that allows us to reach our financial goals or make purchases sooner than later. However, as with most luxuries, there are associated costs. The main cost you’ll incur when taking out a personal loan is interest. Lenders will charge you a premium on the money you borrow, which has to be paid as you pay the loan back. Typically, this is laid out as a percentage of the loan that is owed every year.
You won’t find any lenders who let you borrow $5,000 and request you pay back exactly $5,000. The loan agreement will request you pay back the $5,000 plus a little more in interest. The interest is how the lenders make their money.
You will see other fees on top of the interest that you may be required to pay. Origination fees are a cost you may incur upfront to process the loan. Sometimes you can get personal loans with no origination fee, and sometimes that fee is rolled into your monthly payments, which means you don’t have to pay it upfront. In those instances, you’re still paying it — just not as a lump sum.
If you ever start to get behind on your payments, you may incur other personal loan costs, like hits to your credit and late payment fees. Late payment fees are fixed dollar amounts you’ll be charged if you don’t make a payment on time. Miss enough payments or become too delinquent on one and it may get reported to the credit bureaus. This can significantly lower your credit score and impact your ability to secure funding in the future.
Those who are planning on trying to pay their loan back early should make sure there are no prepayment penalties or fees. Some lenders charge you if you pay the money back early because it cuts down on the amount of interest they will earn. Not all personal loans have prepayment penalties, but some do.
Should you get a personal loan?
Answering the question of whether you should get a personal loan comes down to several additional questions. The most important question is why you are borrowing the money. If you’re borrowing the money for something like emergency expenses, house renovations, medical bills or to consolidate debt, a personal loan could be a great fit. You’ll still need to assess whether you can afford the future payments, but these are typical fiscally responsible reasons to take out a personal loan.
Taking out money through a personal loan to pay for accredited tuition costs, finance a business or buy a house are not ideal reasons for using this type of loan. For one, many lenders will not approve you for personal loans if you’re planning to use them for these purposes. Additionally, there are more appropriate lending products you can use for these instances, like student loans, small business loans and mortgages.
Additionally, using personal loans for things like vacations or buying a new gadget is ill-advised. The better move in these situations is to build a savings plan and wait until you have the funds to complete the purchase.
While debt consolidation is a great use of a personal loan, you need to make sure you’re not perpetuating a debt cycle. Using a loan to pay off maxed-out credit cards opens those credit cards back up to being used, which could just build up debt all over again. If you don’t have the right discipline, you could create a larger problem.
“When we sit down with families in credit card debt, one of the common questions that we get is whether a personal loan to consolidate the debt is a good option. My first question is usually: How likely are you to max out your credit cards again once they are paid off?”Frankie Fegurgur, COO for United Educators Financial Association
“The reason I ask this is because when people shift the debt to a personal loan but don’t change their money mindset and habits, they are likely to run up the charge cards again, and end up with twice the deb that they started. Being able to afford a personal loan is about more than just the APR and monthly payment,” Fegurgur said.
How much loan can you afford?
If you’re trying to figure out how much loan you can afford, you need to look at a few different factors. First, you need to know how much of a loan you can be approved for. Lenders can help with estimating potential rates and approval amounts with some basic information from you. Typically, this can be done instantly and does not pose a risk to your credit score as soft credit pulls are used.
Just because a lender is willing to approve you for a certain amount does not mean that’s what you can afford, however. The approval amount is equivalent to the fiscal amount of risk they are willing to take on. It does not mean they’ve done a thorough look through your finances and future goals to determine what you can afford.
Start by looking at what your monthly payment is going to be for different loan amounts. Factor this into your existing budget to see if it makes sense. If you don’t have an existing budget or know what you regularly spend, that needs to be the first step. You can’t decide on whether you can support an additional loan payment if you don’t know what your current monthly expenditures are.
Once you determine what you can afford each month, utilize a personal loan calculator. Input your estimated rates and begin crunching the numbers to see what your monthly payment would be. You’ll be able to find the right loan size and terms that help you accomplish your intended financial goal. Take this data back to the lenders and secure a loan that fits within your budget.
Even if you can afford to borrow more money than you need to complete your financial goal, don’t take it. Only take out the money you need for this project and no more. It can be tempting to take out the extra money to have fun with, but that’s an expensive way to have a good time.
For more information on personal loans, a personal loans buying guide can be a quality next step. Additionally, not all personal lenders are created equally. This list of the current best personal loans can help to point you in the right direction.
Deciding to take out a personal loan is a major financial move. If you do your homework, find the right lender and only take out the loan size you need and can afford, the borrowing experience can be positive. Personal loans help many reach financial and life goals sooner, but when abused, they can spell trouble.