Think before you borrow

Iona Minton
Thu, 18 Aug 2005

This article is a printout from iafrica.com
Copyright © 2000 iafrica.com*, a division of Metropolis*

While interest charges on loans are a fact of life, there are ways to manage them better. Before taking out a home, car, or personal loan, question whether you actually need it. Make sure you have exhausted all other options, and the reasons for taking on the debt are sound.

Borrowing money to buy a first home is fine, but taking out a personal loan to fund a holiday is not. Here are five factors to consider when taking out a loan.

1) Interest rates matter
What is the difference between 15 percent and 20 percent? Well, if you borrowed R100 000 at an interest rate of 15 percent over a five-year term, your payments would be R2378 per month. If the interest rate was 20 percent, your payment would be R2649 per month.

At the end of the five-year term, the difference in total payments for the 15-percent loan vs. the 20-percent loan would be R16 224! Just think what you could do with that money!

2) The term or length of the loan
Let’s continue with the example above. If you borrowed R100 000 at an interest rate of 15 percent over a five-year term, your payments would be R2378. If you borrowed R100 000 at an interest rate of 15 percent over a three-year term, your payments would be R3466.53; but your total saving by paying off the loan in three years is R17 944. If you can manage it, you should almost always go with a shorter-term loan.

3) Penalties for early payment
Before you sign on the dotted line, check the fine print to see if there are penalties for paying off the loan early. What you find may surprise you.

4) Opportunity cost of borrowing money
Before you take out a loan, consider the opportunity cost. Do you really need that Harley or caravan? You may want to consider other options for recreation activities, or rental options. The money that you will be spending on your loan could be put invested somewhere, and could be building your wealth. Consider whether you really need that loan, or is it for something that can wait?

5) Type of loan
Before you take out your loan, consider your options. Should you roll your loan into a mortgage payment? Use a matured investment? Or perhaps take out a personal loan? There are pros and cons to different loan options and you should shop around before you make your decision.