Loans can be used as additional finance to help us reach our goals, whether you’re using it to buy a house, boost your business, or free up your cash flow. Before you apply for a loan, you’ll need to consider a few factors that will allow you to decide whether you can truly afford it. Below, we’ll look at how to understand the cost of borrowing and a few features that have a direct impact on it.
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Why do we borrow?
There are many reasons why we might choose to borrow money from a lender, whether it’s to benefit our personal finances or our business. Mortgages are loans that many of us will have to apply for in the future, along with other types of finance like credit cards, short-term loans or even payday loans in an emergency. If you run a business, you may require a business loan to help you get started, or grow, allowing you to purchase new premises and train new staff. Generally, borrowing can be a huge help in many situations, and can help us to achieve goals, and free up cash flow when we need it most, so we can avoid falling into financial difficulty. However – it is crucial that you make sure you are able to afford the total cost of borrowing, and that doesn’t just mean how much the loan costs. You’ll need to consider a few factors before deciding whether you can afford a loan which we will look at in more detail below.
What is the Cost of Borrowing?
As mentioned above, the cost of borrowing is not just the amount of money that you are awarded from the lender, various other elements should be included when trying to work out what it is really going to cost you. Here are a few of the main factors to consider when deciding whether you can really afford to borrow money.
- Loan amount: Firstly, think about the loan amount. You should make sure that you know how much you need so that you don’t end up borrowing more money than necessary and having to pay it back.
- Fees: There are often hidden fees that come with loans, like APR as well as any additional fees you may have to pay if you make a late repayment or default, as well as settlement charges.
- Repayments: Think about how much you can afford to pay back each month. This is crucial so that you don’t end up stretching your monthly income too far and restricting your cash flow. This will help you to choose the right loan for you.
- Term: The shorter the term of your loan, the less amount of time you will be making repayments. Although this might mean higher monthly instalments, you will be able to clear your debt more quickly. Lengthy terms mean prolonged debt.
- Interest: This is how lenders make money on their loans, it is also based on credit score and how risky you are as a borrower. You should always factor in interest when thinking about the cost of borrowing to get a good idea of how much you’ll be paying in total.
So, how do you work out how much you need to borrow when applying for a loan, and why does it matter so much? Of course, you’re going to need enough money to help you manage your costs, but you’ll also need to decide realistically how much you can afford to repay. The higher the loan amount, the longer the loan repayment is likely to be, and the larger the monthly payments. You should work out in line with your income how much you can afford to set aside each month to go towards your loan repayments. This means you will be able to choose a suitable loan that won’t land you in added financial difficulty.
Work out interest and fees
Interest rates can be confusing but getting to grips with them means that you will be able to prepare yourself for how much your loan is going to cost. One of the most common features you’ll see when applying for a loan is APR. This refers to the annual percentage rate. Looking at this means you can get a better idea of how much your loan is going to cost in total, as it includes interest, as well as other arrangement fees. As we mentioned above, it’s important that you also familiarise yourself with additional fees that you may come across if you want to settle your loan, default, or make a late repayment.
If you are struggling to manage your debt, or you simply need help working out the total cost of borrowing – there are people that can help you, all you have to do is reach out. You can create your own debt repayment plan to ensure you’re paying off a suitable amount to help you reach your goals and reduce your term. You should pay more than you need to if you can and prioritise your payments so that your credit score remains healthy.