5 Questions to Ask Yourself Before Taking Out a Loan

Can I Afford to Take Out a Loan?
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Anytime you borrow money, finance a purchase, or take out a loan, you should carefully consider if it is the right decision for you. Borrowing money means that you are committing to pay the money back within a certain time frame and at a certain interest rate.

Before signing on the dotted line, you should consider how borrowing money will affect your finances in the future. You don’t want to gamble and guess at whether or not you can afford the payment, how it will affect your debt-to-income ratio, or if it fits into your budget.

So while it may be tempting, ask yourself these five questions before you take out that loan.

Is This Purchase Necessary Right Now?

Often things that seem necessary really are not. You can postpone most purchases until you have saved up the money to buy them in cash, rather than financing or taking out a loan.

For example, while it may not be convenient to go to the laundromat to do your laundry, you will save money by paying cash for a new washer and dryer. If it is for something that is recreational, such as a boat or jet skis, you really can save up the money to buy the items, because they are not necessary purchases. If it’s a larger purchase like a new car, conside buying a used car instead to save money. You may even save up the money more quickly than you expect because you are motivated to make those purchases.

Can I Purchase Something Less Expensive Instead?

Often when you are making a big purchase, you will want to buy the nicer model. But it may be smarter to scale back and buy a used version or lower model instead.

For example, if you are purchasing a car, you may consider getting a more basic model, or, as mentioned, buy a used car instead. Whatever money you save, you can then use towards saving and investing instead.

Also worth noting: It is important to do your research on major purchases so that you know you are getting the best value for what you can afford to spend. This does not mean that you necessarily buy the cheapest item available, because you do want something that will last and be worth the price. Doing research can help you determine the best option at the right price point.

Can I Afford to Make the Payments?

This is an essential question to ask yourself – and it’s important to be honest. You should consider the limits that this purchase may make on your ability to do things in the future. You may not be able to take as many vacations because you do not have the ability to save money as quickly.

Additionally, you may be squeezing your budget that it will be difficult to do anything else, such as go shopping, go out to dinner, or go to happy hour with friends. You may come to resent or regret the purchase.

You should also consider your debt-to-income ratio. You do not want this to be higher than 25%, including your mortgage. If you want to buy a home soon, you need to keep this number even lower.

How Fast Can I Pay It Off?

When you take out a loan you should consider how long it will take you to pay it off. Remember, it is very difficult to build true wealth when you are consistently paying interest to others. When you can turn this around and begin earning money with your money, you will be able to reach your financial goals.

That is why it is important to carefully consider all options before you borrow money. If you do decide to take out the loan, instead of just thinking about making the monthly payments, you should think about ways to pay extra each month.

What Happens If I Can't Pay It Off?

You should also consider the long-term effects if lost your job or suffered a substantial cut in income. This means that you have extra pressure to find a new job quickly because any late payments or skipped payments will affect your credit score.

Depending on the industry you are in, you may have a difficult time finding a job if you have a poor credit history. In short, you need to consider how you will pay this loan off if you were to lose your job. If you are in a one income household or you are single, you need to be very careful about any extra debt that you take on.

Updated by Rachel Morgan Cautero.