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Loans: Better Think Than Sorry                                                 Posted: Apr 2009     

What do you need to think about before taking a loan? What are the risks related to loan? Do you have the contingency?.

Most of us must be thinking that our personal budget could be larger. Simply, our potential spending seems to be always higher than our earning. The difference between income and potential spending is the gap that we are trying to cover by any mean. There are several methods, like looking for a better-paid job or exploring the secondary income streams. One of the methods is taking a loan.

Regardless the fact that the loan have some obvious benefits, like saving our time by borrowing money from future earnings, buying a large assets ( house or car ) that we couldn't buy otherwise, the loan can bring us a lot of personal troubles. It is very easy to enter the traps that every loan conceals.

First trap is the justification of the application for loan. Prior to applying to loan, everybody should ask a simple question: "Do I really need this loan?". This question is important, since easy and quick loans can tempt us to rush into unnecessary expenditure, simply because it was so easy to get it. At same time there are so many attractive things to buy too. For example, you may have a car, a good and reliable, but the new line of your favorite car brand has just been issued and there is a very good loan offer from the bank. And, they got you!
Second trap is the fact that you pay the interest to the bank. The essence of the problem is the fact that most of loan applicant is not fully aware about the fact that bank interest is not that simple and small figure that you consider it to be. A moderate single digit interest in reality turns to be a double-digit robbery. For example if the bank is offering you the € 10.000 loan with 7% interest rate, this does not mean that you will pay the € 700 of interest. Due to the fact that you repay your debt in installments, the interest rate is recalculated cumulatively. If you take € 10.000 loan with 7% of interest on the period of 5 years, it is very likely that you will return to the bank between € 12.000 and € 13.000, or 20% to 30% more than you took. If you took the same amount on 10 years than this goes up to 35-50%. So just imagine that you want a new € 20.000 car and you think that this is a reasonable price. But think again and add, for example, 30% of bank interest. Does it really worth? Maybe your current car is still good enough or you could try a 3-5 years old second hand car?
Next trap is a possible administrational fee that some banks apply. This cost cannot always be easily visible, due to complex banking documentation, but at the end you pay for this extra cost. Also do not forget the time that you spend on application process or installments follow up.
Now come the really scary part. All mentioned by now was feasible. It cost you time and money through bank interest, but at the end you get the money, buy what you want and slowly repay your dept. But all this is under condition that your monthly installment is not taking you a significant portion of monthly budget. But what if your budget suddenly get shrink. This could be for any reason: you or your spouse may get fired, or your salary may be reduced, or the bank may increase interest, or ... So, in this situation you may not be in position to regularly return your installments and everything collapses. If that happen you may need to sell your new car or house, and still must return loan installments with bank interest. Think before this happens. Is your loan too stretching for your budget?

On top of this add other different unpleasant situations like when you have to chase your friends to be you guarantor. Does it worth that relations with your friends get distant because you asked them to be your guarantor?

The loan is something that you may need to apply for eventually. But think twice before you apply for a loan, especially for not crucially important things, as the new car may be while your old car is still good, or vacation in skiing resort that cost you more than you can afford. Think before you decide to do it. Better think than sorry.