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If you need to borrow money to make money – that’s fine. But borrow sensibly so you don’t fall into the
vortex of debt! Here are some general financing tips to help you on your way, and make sure you check out our tips on specific
types of finance - mortgages, Business Loans, Personal Loans, Payday Loans and In Store Finance.
Terminology and Definitions
A loan is just money you borrow from someone (usually
a bank or financial institution) to make a purchase. This loan is a debt to you, because you now need to repay the money plus
a bit more. So the purchase will end up costing you more than the purchase price.
The cost of the loan to you comes
in the form of bank fees (admin fees, processing fees, exit fees, and many more depending on your bank) and interest charges.
This is how the bank makes money.
Interest rates and fees vary depending on the lender and the type of loan. Typically
a mortgage will have a much lower interest rate than personal loans.
Some more terminology and definitions:
Repayment - your monthly repayments are calculated by the lender, and is the amount of money you
must pay back every month to repay your loan. If you don’t make a payment, you may go into default on your loan, which
means the lender has the right to repossess your purchase and engage debt collectors on their behalf.
Your bank/
lender will have a default policy, which will set out when they take this action (usually only if you’re a repeat non-payer),
higher interest penalties on the defaulted payment and other charges. It’s important that you understand the default
policy of your lender.
Ability to Repay - you may have heard this phrase used when applying for
finance. A bank will check your income, expenses and credit history to determine you ability to repay a particular loan. If
the bank doesn’t think you’re able to repay the loan, they won’t (or shouldn’t) give it to you because
you are at a high risk of going into default on your loan.
Some unscrupulous non-bank lenders don’t care
about your ability to repay because they just repossess your purchase and you still have to repay the loan! This is very dangerous
because you can end up in a never ending spiral of debt, and not actually accumulate any assets in the process either.
And regardless of what the bank thinks your ability to repay is, YOU need to make your own judgement. What are the
repayments – can you afford this each and every time a payment is due?
Secured and Unsecured Loans
- With a Secured Loan, you need to provide some collateral that the bank can use if you default on your loan payments. For
example, you might put up your house as security for a car loan. In this case, if you default on your car payments, the bank
can sell your house and recover their costs.
Loans can also be secured by someone else – for example parents
securing a for a car for their son or daughter by guaranteeing to make the loan repayments if the child defaults.
However a loan is secured, you need to understand that if you default on your payments, you could lose your security –
ie the bank will take your house or whatever asset you or someone else used to secure the loan. So take this seriously, and
don’t think of it as an easy way to get a loan.
An Unsecured Loan doesn’t require any collateral or
security, but for this reason it is higher risk to the banks so they will typically charge a higher interest rate. Unsecured
loans can also be difficult to get if you have a poor (or no) credit history, which is why parents so often secure loans for
their children.
Variable and Fixed Interest Rates - Interest rates go up and down with the local
and global economy. And for longer term loans, this means that the interest rate will go up or down during the term of your
loan - which means you will pay more or less interest on your loan accordingly.
That’s great if it goes
down, but when interest rates go up – you can really feel the pinch in loan repayments.
Some loans (particularly
mortgages) allow you to fix in an interest rate (typically a bit higher than the current interest rate) so if interest rates
go up, your interest repayments won’t. Conversely, if interest rates go down, you won’t see the benefit of the
reductions in interest.
Principles of Securing Finance
So based on the above definitions,
the following principles and financing tips apply: - Understand what the loan is actually going to cost you –
interest charges and lending fees. If the loan is lonely for a small purchase (furniture, entertainment system, etc), perhaps
you’re better saving for it instead?
- Compare loans to see which one is actually the cheapest for you –
and read the fine print!
- Can you afford the repayments. What is the repayment – are you able to afford this
each and every payment for the life of the loan? If this makes you nervous, then perhaps you’d better look at other
options.
- If you’ve done your budgeting, you’ll know how much money you have available for loan repayments
– stick to this limit!
- Know how an increase in interest rate is going to affect you – unless you have
a fixed interest rate, rerun the repayment calculations for interest rates say 1 and 2% (even 5% higher) and see what happens.
Can you afford these repayments?
- If a bank knocks you back on your ability to pay, yet a non-bank lender says “no
worries” – be very very cautious!
- If you take out a Secured Loan, think very carefully about the consequences
if you default on your payments. Are you prepared to live with these consequences?
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