Borrowing Money: The what and what not

Source: Money SENSE worksheet on Borrowing Money (2010)

Some of us would probably need to borrow money at some point in our lives. It may be for education, for our home, for some household appliances, or even for some luxury items. Whatever our purpose for borrowing, we should always take into account that "excessive borrowing may lead to financial trouble".


So how do we assess ourselves before we decide to borrow money? Here are some issues highlighted in the worksheet:

1. WHEN SHOULD I BORROW?

This is the big question. To help you assess your need to borrow money, you must ask yourself:

• Do I really need it? Or is it something that I merely want?
• Must I have it today?
• What will happen if I do not buy it today?
• How have I managed so long without it?

If you think you really NEED to buy something, assess your finances if it's necessary to borrow to buy it. "You will be better off saving for it and paying in cash to save on interest charges." Again, the stress it to determine whether it's a WANT or a NEED. I think the purchase for a want can be postponed (or even set aside) while buying a NEED is immediate.

If you do decide to borrow, it would be better to "take a smaller loan so that you do not overstretch yourself financially". Take into consideration the total borrowing costs including total interest payable BEFORE you borrow. Make sure that you are able to afford the loan payments.

Tips:

• "Before you borrow, try saving an amount equal to your expected monthly loan instalments."
• this is a good gauge of your ability to make monthly loan payments
• if you can wait a little longer, you may not even need to take a loan after all since you are able to save the same amount!
• "Work out your monthly income and expenses to see if you have any remaining funds to pay for the loan instalments."
• if there is nothing left every month after deducting your expenses, how will you be able to pay for your loan?

2. IF I DO BORROW, WHAT ISSUES SHOULD I CONSIDER?

When you do decide to borrow, bear in mind that there are repercussions (positive and negative) depending on how you repay your loan. It's better to consider the following issues when you make the decision:

• How much to borrow?
• "Borrow only up to the amount you are comfortable with." With this in mind you have to determine what is comfortable in terms of repaying the loan, especially for long-term loans. This is because you may qualify for bigger loans, but considering other market and financial factors, it may not be wise to maximise the loan amount offered to you.
• Bear in mind that "small differences in interest rates can make a big difference in the total amount you will need to pay, especially in cases of long-term loans".

For those swayed by 0% interest or Interest free instalment plans, a word of caution - READ the terms and conditions THOROUGHLY. These schemes come conditions like full payment every month otherwise you pay :interest charge as high as 24% a year on the lump sum that you roll ever!" There may also be a late charge ($$$) if you don't pay your bill in time.

• Protect your credit standing
• You might not be aware of it but "lenders use credit reports, containing your credit history and current financial situation, to decide whether to lend you money". 
• "A report that shows defaults or late payments - even 30 days late - might lower your chances of getting a loan or require you to pay a higher interest rate for a loan."
• To get a copy of your credit report from Credit Bureau Singapore (CBS) you can log in to www.creditbureau.com.sg
• CBS issues credit reports of consumers, obtains information from its member financial institutions and public sources such as bankruptcy data.

Tips:

• "Pay every instalment promptly." Every late payment may cost you additional $.
• "Your monthly long term debt commitments should not exceed 35% of your gross monthly income." Based on this if you are earning $5,000 a month, your long term monthly loan should not be more than $1,750. 
• "Always keep track of the payment dates for your credit facilities and remember to pay before the due date. Pay your monthly outstanding credit in full to avoid incurring interest and paying penalties." Put a reminder in your phone or computer calendar for the due dates.
• "Avoid multiple sources of credit. It is easier for you to keep track of our repayments when you have fewer credit facilities." But in this world where credit cards are usually given out for free, it may be difficult to resist. So if you do decide to take up multiple credit sources or credit cards, note down the payment dates.
• "If you are unable to meet the payment deadlines, let your financial institution know and explain the reasons for them." Some institutions may be able to waive late fees if you have a valid reason for making late payments.

Last thing to consider when borrowing money....

• Shop for the best deal
• It is your responsibility as the borrower to know the loan terms and conditions. It is your right to ask the financial institutions for these information before signing any agreement.
• What is the effective interest rate and advertised rate?
• What are all the fees involved?
• How much will I have paid in interest when the loan is paid off? ---  I think most people actually ignore this part of financing the loan. If you sum up the interest paid throughout the loan period, especially if you have a long-term loan, you will realize that your have paid a big chunk of money just for interests.
• Can I pay it off early without penalty? --- Some loans, like home loans, have a lock in period wherein you cannot make any capital repayments otherwise you incur a cost. Make sure you are aware of the conditions of your loan in terms of paying off early.
• "Shop around and compare."
• If it sounds good to be true, it might not be.
• "Read and UNDERSTAND the fine print and terms and conditions." I cannot emphasize this enough.

Tips:

• "Save money by taking a short loan period, especially for items that are used up quickly (like a holiday) or depreciate in value (like a car)." You will be saving on interest payments.

3.  HOW DO I MANAGE MY LOAN?

Once you already have your loan, the next thing to do is to pay off that loan, as soon as you can. Here are some suggestions on how you can do so:

• "Increase your regular payments." You can talk with financial institutions to increase your monthly repayments to help you pay up your loan faster. If you have extra savings every month and not intending to put that money in any investment, and you have enough emergency cash in mind, you can consider allocating part of this to your monthly repayments.
• "Make lump sum repayments." You can use your bonus (if any) or some parts of your annual savings to make lump sum payments. You should inform the financial institution first and ask for any charges for doing so.
• "Reduce debts." Rule of thumb is to pay off the debt with the highest interest first.
• "The faster you reduce your outstanding balance, the less interest you will have to pay." With this in mind, I think prevention is better than cure. By this I mean, borrow less so you can pay your debt as soon as possible, that is if it is really necessary to borrow.

I hope this helps especially for those who are looking into borrowing in the immediate future.