What should I know before I take out a personal loan?

Published on March 3, 2016 9:31 am, by

Is personal loan good debt or bad debt?

Traditionally good debt is defined as debt that has an asset that is appreciating in value attached to it.  This could include a mortgage, money borrowed to invest in shares, and even payment for education. 

Bad debt is thought to be debt that is taken out for a lifestyle choice.  It generally has no asset attached or one that depreciates in value.  This could be a personal loan taken out to fund a holiday, a credit card that isn’t paid off in full each month and a loan taken to purchase goods that you can’t afford to buy outright.

Like everything though, there are degrees of bad and degrees of good.

Some good things to use a personal loan for

What’s better?  A credit card that you just can’t reduce, with a 21% interest rate that comes with a late fee attached those months you can’t afford the minimum payment or a 12% personal loan, with set repayments that you can afford each month once you get the loan term that is right for you.

The problem with doing this (and the reason we don’t advocate it here too heavily) is that many people who refinance their credit card debt in to a personal or home loan keep their credit card open.  And then in twelve months they are in the position of having to repay the credit card again and repay the personal loan.

Some not so good things to use a personal loan for

Using a personal loan to fund a holiday that you can’t afford, or purchase goods that you can’t afford are all referred to as bad debt.

Rather than taking out debt for these lifestyle choices, saving is a good option.  Taking out debt for these things help you live a life that you can’t afford and limit your buying power for assets you may wish to purchase at a later date.

Things to think about when taking out a personal loan

How quickly can you repay it?

Do you really want to take a holiday – granted you will probably enjoy it greatly – and be still paying it off in 5 years?  Think about what you are doing with the personal loan, and consider matching your loan term to your future expectations.

Do you want to take another holiday in 2 years?  Will you take out another personal loan in 2 years that you will be repaying at the same time as this one?  Check your finances and be realistic.  The quicker you can pay the loan off the quicker you can start saving.

Finding the right personal loan

Canstar is a great site to help you compare products across the financial services industry.

On the site you are also able to access calculators that enable you to compare time-frames for repayment, repayment amounts and select a product and term that suit you.

A word of warning

If you are planning to take out a personal loan to repay higher interest debt that is holding you back, make sure that you close off the other facilities once they are repaid.  You don’t want to be paying a personal loan and have a credit card debt again in twelve months.

Do your budget and make sure that you are spending less than you earn.  Factor in the repayments on your loan, and try to pay it off as quickly as possible.  If possible set up an automatic payment on payday from your transaction account to your loan account.

Check all applicable information, know if you will be charged a late fee if you are late.  Know if you will be penalised if you pay your loan off sooner.  Use the guardrails for the product to help you select the right loan for you.

Related Articles –
Beating Credit Card Debt
Credit Cards – An expensive lesson
5 steps to start saving

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Jen is an experienced banking professional who loves wine, coffee, finding a bargain and of course her three beautiful children. Since Jen's first budget led her to buy a home at 20, Jen has passionately helped others to make better decisions with their money.

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