How To Ensure That You Really Can Afford To Borrow Money
While the widespread availability of credit has made it easier to borrow even if you have a bad credit record, that doesn’t mean that this means lending is ‘easy money’. All credit must be repaid over the term of an agreement if you don’t want to end up with a poor credit record, defaults registered against you or find yourself the subject of legal action.
You may have had trouble with borrowing in the past and been late with some repayments or worse. This will have affected your ability to get credit now and you may have been rejected by some or all of the mainstream lenders and high street banks.
The key to responsible borrowing is affordability. That means taking a fearless and honest look at your income and expenses and assessing whether you will be able to make the repayments on a potential loan throughout its term without fail. What if your circumstances change? You may lose your job or be faced with a household or medical emergency. Will you still be able to comfortably make the repayments then?
The first thing you should do when you are considering taking out a loan or other form of credit is draw up a budget. This is the only way to determine whether the repayments that you will face will actually be affordable. It will show you how much money you have left over when you have met all of your existing commitments and paid all of your living expenses.
What does a household budget look like?
It’s easy to kid yourself with a budget. Just including the fixed monthly outgoings is a common mistake and completely ignores all the other things that you need to live – heat and light, food shopping, unexpected contingencies, letting your hair down occasionally, etc.
So when you set a budget, divide your outgoings into two columns: fixed and other items. The fixed items might be the expenses that you pay by direct debit or standing order and include:
- Your mortgage or rent payments
- House insurance
- Gas bills
- Electricity bills
- Water rates
- Any mobile phone contracts
- The payments on your landline
- Car insurance
- Car tax
Also on your fixed list should be regular payments you make on existing credit agreements. These may vary between the minimum monthly payment and higher amounts when you can afford it but try to be realistic about what you should be repaying each month to reduce the overall amount of the loan:
- Credit cards
- Store cards
- Loans – both secured and unsecured
- Car finance and other forms of hire purchase
- Pension contributions
- Life insurance
In most cases, these make up the total of fixed monthly outgoings which must be met no matter what. Now, in your second column, list all of the outgoings which are subject to change:
These include but are not limited to:
- The cost of travelling to work (fuel for the car, rail season tickets, etc)
- Vehicle maintenance (you should be putting aside a certain amount each month to cover annual servicing, MoTs, unexpected breakdowns, etc)
- Food shopping
- Your clothing allowance
- Cleaning and other household products
- Childcare costs
- Any maintenance payments you have to make
- Extra school costs (trips, memberships, etc)
- Entertainment costs (this includes everything including eating out, coffees during the day, lunches while away from home, lottery tickets, the costs of any hobbies, trips to the cinema, magazine and newspaper purchases, etc)
- Gym membership
- Saving for holidays (this is the prudent way to pay for holidays – by factoring them in to your household budget)
To help you draw up this budget, get all of your bank statements and credit card bills for the last six months so that you don’t miss items that are paid quarterly or every six months. Try to build in a contingency fund so that you know you’ll be able to cover unexpected emergencies like needing a new boiler or a sudden problem with the car.
When you’ve listed everything, you should know exactly how much you should be spending each month to maintain your existing lifestyle and commitments. How much money is left when you have deducted this total from your monthly income? Could you continue to afford all of these plus the extra borrowing you are considering should you lose your job or become ill?
If you are finding that meeting all of these is already difficult, then be clear that taking on extra borrowing is only going to make things harder. In these circumstances, you should consider reviewing your monthly outgoings and seeing where you could make savings. Obvious items to cut would be your shopping bill by going for supermarket own products rather than brands, cutting down on your entertainment items or perhaps settling some credit cards or loan accounts early.
If you’re finding it hard now, that should be a warning
If your household budget clearly shows that you have barely anything left over from your paycheck each month or, worse, you’re regularly in the red, then the simple truth is that you probably cannot afford to take on more debt. You really shouldn’t be adding to your worries but should be earnestly looking for savings so that you can reduce your existing amount of outstanding debt.
There are valid exceptions to this, though. One of these is debt consolidation where you use a new loan to pay off some or all of your existing debt and so reduce your monthly repayments and the total amount of interest that you will end up repaying.
Article provided by Mike James, an independent content writer working together with Solution Loans, a technology-led finance broker with over 10 years’ experience advising clients of their most suitable types of finance.