Knowing Your Limits: 5 Things to Consider When Determining How Much Loan You Can Really Afford

Are you ready? Taking out a loan can be a big decision. The necessity of whatever you are borrowing funds for (car, home, studies, etc.) shouldn’t leave you with insurmountable debt in the future.

Use these five points to help you stay within your repayment limits.

  1. Your budget

The first step is working out your monthly discretionary income (money left after taxes and expenses). That way, you know how much money you can safely earmark forloan repayment.

It may mean cutting some current expenses, like nights out with friends, or delaying purchases (for new furniture, for example). It could also mean having less money to save, but remember, it’s wise to maintain an emergency fund even by putting aside the bare minimum monthly.

  1. The interest rate

The interest rate applied to your loan determines both your monthly payment and the total repaid over the life of the loan. The rate you qualify for depends heavily on your credit score. You can check here for ways to find it out.

Don’t go by the advertised rates for the loan you are considering. These tend to only apply to persons with high scores. A lower score means a higher rate, with even a fractional increase leading to a big jump in monthly repayment. You can use this loan calculator to give you an idea.

  1. Length of the loan

Extending the repayment period may seem like a good idea at first, but it is something you will want to consider carefully. A longer period reduces the amount of money you will have to find monthly to service the loan but increases the total paid over the life of the loan.

While the lower payment may be easier on you now, it may mean having to wait longer before you are able to fit any new expenses into your budget.

  1. Hidden costs

There are often hidden costs which you incur when you take out a loan. Whether the loan is to purchase a car or home, for example, there are the costs of insurance, maintenance and repair to factor in. Buying a house also adds inspection fees, property taxes and homeowner’s association fees (if you buy a condo) which you will have to pay.

It is not unusual for prospective borrowers to forget these added expenses only to be blindsided by them later on.

  1. Shop around

Take the time to compare different loan options from different lenders. Even if there is an urgent need behind you taking out the loan, always keep in mind that whatever decision you make is one you will spend years paying for.

Shopping around also includes not getting fixated on a particular purchase.For example, keep an open mind and admit to yourself that the car you want and the car you can afford may not be the same car.

As you try to determine the amount of loan you can afford, always remember: don’t under budget, don’t overspend and don’t rush into it. Stop and consider the points we’ve laid out and you will find your final decision on how much to borrow is one you can live with.

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