How to Use Personal Loans in 2021

 

Nobody likes going into debt, but right now for many of us taking out a loan is unavoidable. So how do you do it responsibly, without harming your long-term financial health and while also keeping the debt collectors away from your door?

 

The pandemic and lockdown have forced many people to dip into their emergency reserves, but the ones who didn't have money set aside have had to try their luck with a loan. This is a tough situation because many South Africans were already struggling with debt before COVID-19 – 37% of people surveyed by TransUnion in 2020 said they were concerned about being unable to repay personal loans. Student loans, car payments, home loans and store accounts were also reasons for people to be worried, and about one in four respondents still planned on borrowing money from friends or family to pay off their bills and loans.

 

Think carefully about why you're taking out the loan

 

"People take out loans for three primary reasons," says certified financial planner Gerald Mwandiambira. "The first is to pay for personal emergencies, simply because they don't have sufficient savings to cope with financial shocks."

 

Then there are people who live beyond their means but don't want to compromise on their lifestyle or expenses. "These people are usually good payers, so they tend to have high credit scores," Mwandiambira explains. "That makes loans an easy outlet for them."

 

The third category are the red-flag borrowers – people who take out loans because they don't understand how much taking on the debt will cost them in the long term. "These people are not financially savvy enough to understand interest rates or how to manage the contracts. They often default on their loans and end up in financial ruin as a result," Mwandiambira says.

 

So when should you take out a loan?

 

Okay, so not everybody borrows money because they just have to have those Bali pics for Insta. Some borrow to pay for genuine emergencies, or for education, or a home. That's the difference between what financial planners call "good debt" and "bad debt".

 

Also, don't take out a loan if it's going to break your budget, warns Mwandiambira. "Only do it if the repayments are well within your affordability range, and if you've exhausted all other avenues, like sitting down with a financial planning professional, going through your budget and seeing if there are other ways of cutting expenses. Personal loans typically come at very high interest rates, and they are very difficult contracts to get out of."

 

Interest, the real cost of debt

 

There's a simple reason why you have to be careful with loans. The interest you'll pay on the money you borrow adds up quickly. While compounding interest is your best friend when it comes to growing an investment, it becomes your enemy when it's applied to money you owe.

 

For example, if you pay off a R5,000 loan over 54 months at an annual interest rate of 21%, your monthly payments will be about R210, but by the end of those 54 months you'll have paid a total of nearly R10,000. That's double the original amount. Scary stuff!

 

Your credit score is a big deal

 

Your financial standing is an important aspect of taking out a personal loan, especially when it comes to your credit score. A good credit score (720 or higher) could qualify you for a lower interest rate, which means the total cost of the loan will be lower. (If you don't know it, you can discover your credit score as well.)

 

Unfortunately, it's not always clear what interest rate you'll be charged. "Because interest rate figures are not always advertised clearly, people often don't factor them into their decision-making," says Mwandiambira. "If people knew what the interest rates were, they would shop around more."

 

And that's why it's so important to compare personal loans. Remember, personal loans are regulated too, and are a safer option than using loan sharks. (Regulated means they won't loan you the money if you really can't pay it back.) Use our online comparison tool to see what's available, and then make an informed choice based on what's best for your circumstances and your pocket.

 

This article is for informational purposes only and should not be construed as financial, legal or medical advice.