The Pros and Cons of Taking Out a Loan: A Guide to Making the Right Decision
The information contained in this article is for informational purposes only and is not related to any advertising offer. Calculations may vary by product.
The author of the article is the editorial staff of an E-Ednna.
Credits and loans are all around us. Every moment we are participants in discussions on the topic of borrowing money or not. Mostly it is the older generation who say: “don’t borrow, buy only what you need!” They are right in a way, but not completely.
To make the right decision, it is important to consider three things:
- What do I borrow for?
- What type of loan do I take?
- What is the ratio of my income and repayment?
It matters a lot because today it is very easy to borrow money. Attractive offers are all around us. Shops are full of expensive goods. New and nice apartments and houses are being built. The marketing campaigns of financial institutions attack us from all sides. It is not a problem to borrow money and it is not a problem at all what to spend it on. So let’s first think about what we will need the loan for.
What do I borrow for?
There are things that we do not necessarily need to live. Consumer goods generally belong to this category. A home cinema is something we can do without and it is not advisable to rent it. The set for €3,000 in instalments will make us happy for a while, but we will have to pay it back in the next three years. After three years, we find that we have paid more than €4,000 in total and we have a shop worth several hundred at home. And a new super system at a super price is laughing at us from the window.
An even worse situation occurs when buying a holiday in instalments. “Buy now, pay later” … similar slogans are used by travel agencies when selling tours. Enjoying a great fortnight in an exotic destination is a pleasant thing. But then to pay for twelve months for something that no longer actually exists? It is very difficult to find motivation for that.
In general, it can be said that debts for consumer goods are bad debts. The interest rates tend to be very high and the value of the manufactured items decreases very quickly.
There are things without which it is very difficult to live. For example, a roof over your head. Whether it’s an apartment or a house, it’s something that makes sense to acquire on debt. If we finance housing with a loan with reasonable interest (the most common is a mortgage), then it is one of the few good debts. We will buy a family house for €80,000 and start making payments. Although we have debt, we also have something valuable on the asset side. If our economic situation worsens, we can sell the property and pay off the debt. This is not the case with debt for consumer goods, because the value of the goods is many times lower than the debt after a year. In addition, we save on rent when purchasing our own housing.
In general, it can be said that housing debt is good debt. What type of loan do I take?
A lot depends on choosing the right type of loan. The interest rate varies greatly between products. We can borrow money for 3%, but also for 30%. So let’s take a look at what debt we can buy today:
Mortgage: usually low units of percent
Consumer loan: 10 percent and more
Credit card: 10 percent and more
Overdraft: 10 percent and more
Non-bank loans: lots and lots of tens, sometimes hundreds of percent
What is my income-to-repayment ratio?
It is very important that our family budget is not “over the top”. Debt repayments should not exceed 40% of the total income. At the same time, the higher the ratio of income and repayment, the more important it is to have ready solutions in case of loss of income in the form of an insurance policy or a short-term reserve. For more details, see the articles “Learn about insurance” and “Types of family reserves”.
There is one more type of loan that we haven’t talked about yet. It is called a consolidation loan. This type of loan serves to combine several debts into one. As a rule, the repayment is reduced by consolidating bad loans and stretching the maturity. A consolidation loan looks very tempting, but it is very dangerous. A separate article is devoted to the details of the consolidation loan. If you should find yourself in a situation where you need it, study this article very carefully. An executor is very often behind an unmanaged consolidation loan.
Getting into debt is very easy. Only take on good debts. A good debt is one that helps you get rich. Buying consumer goods on debt will not help us get rich. Take out a mortgage to buy your own home, but do it wisely. It pays to have a financial plan drawn up by a professional financial advisor.