If you are facing tough financial times, taking out a loan would seem to be the best and smartest thing to do especially if you have a steady job that can pay off your loan. Before you get too excited about going into long-term debt to handle short term financial challenges, you need to keep in mind that there are three common factors that borrowers fail to take into consideration when they take out their loans.
This is understandable because they are facing desperate times and need to act quickly or risk sinking further into debt. Still, if you don’t want to create more problems taking out a loan, keep the factors below in mind. Your best bet might still be taking out a loan However, if you factor in the issues described below, you might have been better off negotiating better loan terms.
If you are paying down a mortgage, you would know that most of your payments go to pay off the interest on your loan before the payments start cutting into the principal amount. That’s the power of compound interest. The longer you take to pay off your loan completely, the more interest you pay. This is a necessary evil when it comes to mortgages because, hey, who has $300,000 lying around, right?
However, when it comes to smaller loans of around $50,000 to $100,000 or so, it is a good idea to factor in compound interest charges before signing on the dotted line. If you don’t pay attention to this factor, you might as well sign your life away on the dotted line. Not a good move. You don’t want to trade in a permanent financial problem for a temporary one.
Another key consideration many borrowers fail to take into account is the role of inflation. With the passage of time, the prices of goods and services tend to rise. If your income remains fixed or rises only slightly with time, your purchasing power is reduced over time. You can’t ignore inflation when taking out a mid to long-term loan, inflation can cut into the amount of money you have budgeted to put food on the table and a roof over your head.
Eventually, these creeping costs will cut into the amount of money you have left over to pay off loans. Always make space for inflation when calculating how big of a loan you should take out.
Last but not least, you should budget a ‘cushion’ in your loan payment amount to protect you from unexpected emergencies. Emergencies pop up at the least opportune time so it’s better to take out a much smaller loan than leverage yourself to the gills and cross your fingers that no nasty emergencies pop up in the meantime.
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