Taking out a loan - things to consider

25 December2009

What are the most important factors when taking out a loan?

What do you want the loan for?

The purpose of your loan may affect your decision on a number of things: whether or not a loan is likely to be worthwhile for you, what type of loan you should take out, etc.

Let`s take two contrasting examples: a small loan for 500, and a larger loan of 8,000.

It`s important to remember that any loan is a financial commitment, and you will be expected to make repayments regularly and on time. Consider whether the small loan would be worthwhile in your circumstances - you might be better off saving up for smaller purchases, and you wouldn`t be exposed to any potential debt problems this way.

Also consider that smaller loans tend to come with a higher interest rate than larger loans, meaning that you will pay a higher proportion of interest, and your debt could grow more quickly if you miss any payments.

A loan for 8,000 would obviously be a much bigger commitment, and you should be especially careful to ensure that you will be able to meet your repayments on larger loans. The upside is that most lenders tend to offer a slightly lower interest rate on loans of more than 7,500.

How long will the loan take to repay?

The repayment term (duration) of your loan can greatly affect the amount you pay overall.

For example, a 3,000 loan with a 5% interest rate over three years would cost 3,236.86 to repay in full (the amount you`ve borrowed, plus interest). Extend the repayment term to six years, and you`d pay 3,478.67 - 241.81 more.

It`s not just about how much it costs, though. In fact, the overall cost is largely irrelevant to many people, so long as the monthly repayments are manageable. But consider that the longer you take to repay the loan, the longer you are exposed to the risk of missing payments if something goes wrong. It`s best to have some kind of `backup` in case of any problems, e.g. savings.

Secured or unsecured?

Deciding between a secured loan and an unsecured loan is an important decision that can affect how much you`ll pay, as well as the risk to your financial wellbeing.

Secured loans, in which one of your assets (usually your home) will be put down as security against the deal, often offer lower interest rates and longer repayment terms than unsecured loans. However, remember that securing a loan against your home is a big commitment, and failing to repay a secured loan could result in your home being repossessed - so only take out a secured loan if you are positive that you can afford to repay it.

An unsecured loan will typically have a higher interest rate than the secured equivalent, and repayment terms are typically limited to seven years. But because it`s a `safer` type of loan - you`re much less likely to lose your home if you miss payments - many people prefer unsecured loans.

What`s the best interest rate for my circumstances?

It may sound like a simple thing, but the interest rate you are offered is an important part of borrowing money.

A lot of people apply for the first deal they find, without considering what they`re likely to pay in interest. But taking the time to search the market and find the best loan deal for your circumstances can save you a lot of money.

There are a number of comparison sites that can help you to do this, but keep in mind that not all lenders advertise on these sites, so it`s worth having a look around yourself before you apply for anything.

Also remember that if your credit rating is less-than-perfect, you may not have access to the best advertised interest rates. Rejected applications can damage your credit rating further, so it`s worth speaking with an expert loans adviser about where to find loan deals that suit your circumstances.

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