Understanding Loans: Are They Safe Or A Debt Trap? |ADDICTED

Loans are up there with spiders as one of the irrational fears that some people have. They seem so terrifying – you borrow money and are instantly in debt. Plus, think about all the loan horror stories you’ve heard. Almost every instance of someone ending up in terrible debt starts with a loan or a credit card.

It’s easy to jump to conclusions and label loans as a bad thing that you should avoid at all costs. However, you have to appreciate that they’re a financial tool you will come across at some point in your life. You may need a student loan, or, you might take out a mortgage; either way, most of us will apply for at least one loan in our lifetime.

So, you can be scared of them, or you can understand them. With that in mind, here are the key factors to consider when applying for a loan:

Photo by Andrea Piacquadio

What is a loan?

The principle is straightforward: you borrow money from a financial institution and have to pay it back. Most issues occur when you take interest rates into account. Some loans have admin fees attached, but most lenders will make money via interest rates. In essence, this is a percentage that you’ll be charged until the loan is paid. It’s added onto what you owe, meaning it works out as the fee you pay to borrow money.

When you’ve paid off your loan, whether it’s a $1500 or a $20,000 loan – plus interest – you will be out of debt, and the contract will conclude.

What are ‘loan terms’?

A loan term refers to the duration of the loan and the conditions you must follow. For example, you could borrow money under a 1-year term that it has to be paid back in 12 months, with monthly payments split equally. Think of the terms as the rules you need to follow to pay off the loan. It’s not that hard to understand, but you should always check the term before you sign a contract.

A small loan might have a repayment period of two years, while a car loan maybe 5, and a house 25, it typically depends on the amount borrowed along with the applicant’s ability to repay it.

Are loans safe?

Now that’s a tough question because the answer is, maybe. If you can afford the loan and it has decent terms, it will be safe. You can easily manage the monthly payments and repay what you owe in the allotted time. In some cases, you might repay the loan before the term ends! Therefore, you’re not in any danger as you’re financially capable of dealing with the loan.

Loans are only unsafe when they have terrible terms, and you’re in a bad financial position. Luckily, there are some safety measures built in to prevent you from getting a loan you can’t afford. For example, credit checks are required on most loans. If you have a poor credit rating, you won’t be able to apply for most loans. Problems occur when you find a lender that doesn’t do a credit check and will lend loads of money without considering your circumstances.

The riskiest loans are payday/short-term loans. These loans will mean you have a short period to repay them, with massive interest rates. It’s a good idea to avoid these loans at all costs.

How should you apply for a loan?

Listen, there are instances when you should apply for a loan. For example, when you need to buy a house. You almost certainly can’t afford the price upfront, so a mortgage will help you out. If you need a loan, how should you approach the application?

It begins by working out the actual cost of the loan. There are tools to help you calculate home mortgage costs, meaning you know exactly what the loan costs each month. Other personal loans have similar tools available, letting you understand what you’ll pay. This is highly beneficial as you can start budgeting and looking at your finances to see if you can afford the loan or not. It should stop cases where you borrow money and struggle to keep up with the monthly repayments.

Secondly, it helps if you only get loans from banks. Don’t opt for dodgy payday loan websites or a random shop on the street. Banks follow strict regulations and will be more strict when viewing your application. It means they have determined that you can repay the loan if you’re approved. Lastly, be sure to improve your credit score as it impacts the interest rate you’re given. The lower your score, the better the rate!

You should make sure to monitor your credit score, and research to find ways to raise it. On-time payments, amount of credit used play the most significant parts in that rating, so be informed on what you can do to make it better.

Loans can be scary, but they can also be very safe. It’s all about understanding how to approach loans and avoid falling into a debt trap. So know your situation, how much you’re able to pay back, and make sure to make a plan and stick to it.