When you’re getting a loan to buy a car, a house or for any other major purchase, lenders typically give you an estimate of how much you can borrow. Although this estimate is a good place to start, there are many other considerations that you should take into account.
Banks often look at your monthly income and debts to decide how much you can afford to pay monthly against this new debt. But what they don’t take into account is your lifestyle and financial obligations. For example, if your children go to an expensive private school, this may not be considered. If you are planning to upgrade your residence and pay more in rent and utilities, you may be aware of this additional cost, but lenders won’t.
The point is: When it comes to borrowing you are the best judge of how much you can afford to pay back. Lenders typically will provide the maximum amount they can lend you, but it is your duty to say, “no, I can’t afford more than that much.”
To decide how much to borrow, you must look into the following points.
Disposable income
If you’re replacing a car lease with a car payment, you might have a guideline for how much you could afford. You probably would like to keep your payment at the same level or less. But if you’re taking a personal loan for something that you haven’t been paying for, that is when your decision should be largely based on your disposable income.
For example, will you be financing new furniture? Ask yourself how much could you spend on this without stretching your budget too thin. The answer depends on where the money is coming from. Will you be cutting back on your savings? Sacrificing other luxuries? You must be sure you know the source of the payments before you commit to them.
Future obligations
Your new furniture or your overseas trip is probably not the last thing that will come up for the next two, three or four years and will need financing. So if you expect a major expense in the near future, think of how the payment you’re accepting now will fit in your future budget.
In addition, account for inflation. If you’re one of the many people whose salaries don’t keep pace with inflation, you must not stretch yourself too thin, especially for a luxury item. Keeping a cushion of savings and disposable income is a good strategy. It also will help you be less stressed out about making end meet every month.
Be conservative
If you’re borrowing to buy something, be conservative. Borrowed money comes with a high price tag, which is the interest rate you pay on it. Although it sounds easy to add thousands of dirhams extra in debt, when your monthly payment increases only slightly, the overall cost of your loan is higher. If it is an item that is nice to have rather than need to have, don’t be carried away.
Making small savings on the cost of your loan can help you pay it off quicker. So instead of going with a high amount, long term and low monthly rate, consider taking a smaller amount and paying it over a shorter term. This strategy should help you lower your interest rate and get rid of debt sooner, which should provide you with the security of mitigating the unknown.
Know the full cost
People often focus on the loan amount and forget about fees and interest rates, which add significantly to your cost. To make an informed decision, ask your banker to provide a full breakdown of your payment, and know what fees and interest are paid. In addition, know how the interest is paid back.
Are you paying the interest on the loan first or is it divided over the life of the loan? The reason you need to know is to know how much you will owe the bank, say in a year or so. And whether this amount will be manageable to pay back if your car, for example, depreciates in value or you lose your job.
The writer, a former Gulf News Business Features Editor, is a Seattle-based editor.
Limit your loan amount
Know how much you can afford
Expect changes in your budget during the loan term
Know the cost of the borrowed money and how it is paid
R.O.
