Category: Loans


How to Decide Whether it is a Good Idea to Borrow Money

Borrowing money can be a big responsibility. You will not only have to pay it back but you will have to pay interest on what you have borrowed and that can add up to a lot. How much you get charged will depend on the type of loan and the term of the loan, but unless you can find interest free options, which are rare, you will always have to pay to borrow money. Although companies such as do seem to offer highly competitive rates!

It is wise to always work out how much the loan will cost you in total. Calculate the interest amount each month then multiply that by the number of months that it will take you to repay and that is the real cost of the loan. That is assuming interest rates remain the same. This could be a great deal of money. For example a 250,000 mortgage at 5% would cost 12,500 a year and over 25 years that would be 312500, which is more than the cost of the house in the first place. That sounds really scary, but a mortgage is an exceptional loan as it is much longer term than most and the home should increase in value over the term enough to offset that cost. However, a credit card purchase can be very different. Imagine you buy a meal out, some drinks, new clothes and accessories and fill up your car so that you can have an evening of fun. That could add up to 250 and the interest will be higher so lets assume 7.5% this means the interest would be 18.75 a month and if you only paid the interest each month for a few years you could end up paying out 450 before you even start to pay back what is owed. That means that the evening out costs you almost twice what you paid for it. It is worth doing this calculation before borrowing any money to work out whether you think that the item that you are buying is worth the real cost that you will be paying for it, once you add on the loan charges and interest. This is harder when you are calculating it for an overdraft or credit card, but look at how much it will cost a month and consider how long it is likely to take you to pay it off.

The cost of the loan is determined mainly by the interest rates, although there may be some additional fees as well. So if the rates are high then it will be much more expensive to borrow money. Therefore you may conclude that if interest rates are low and it is cheap to borrow money then it would be sensible to do it then. It is not as simple as this though as the base rates change. They are reviewed on a monthly basis and they can be changed up or down by any amount. These base rates are the rate that banks can borrow at and if it is more expensive they will charge their customers more for borrowing as well. If they are cheaper they may charge their customers less. However, if you have a variable rate on your loan, then the lender can change the rate whenever they like by how much they want and therefore may not follow the changes in the base rates. This means that there is a lot of uncertainty and it is hard to predict what may happen. It is easier to predict the short term, but even then there is no certainty and so you need to be prepared for the loan to be more expensive than you first calculated. Therefore you need to make sure that you have more than enough money to cover the repayments.

It is also worth looking at the time of life that you are in and whether you want to take on the responsibility of a loan. Think about what life events might happen in the future, but within the term of the loan which could make it difficult to manage. You might settle with a partner, buy a home, have children, retire, become unable to work or something else which may affect your ability to repay a loan and so it is worth a lot of thought.

It is not an easy decision to make. You need to weigh up how important it is for you to have the money and compare that with the cost of it. Think about your ability to pay it back and whether the cost is likely to go up over time. Imagine the future and whether you think you will be able to keep paying it back even if there are changes in your future. There are a lot of things to consider and it is something that you should take time to think about and it could even be wise to discuss it with other people before you make the decision.