6 Times When It's Okay to Take a Loan
Loans are a tricky subject in the financial world, because ideally, you'd never really need one. In the real world, however, plenty of responsible people find themselves needing loans for legitimate reasons. (See also: 6 Times You Should Never Take a Loan)
Whether it's an unplanned financial emergency or a necessary, major purchase, there are some situations when taking out a loan can't be avoided. Read on to understand when a new loan is actually okay.
1. When You Can Easily Afford the Payments
This might seem like a no-brainer, but when people are desperate they will sometimes assume loans with large payments they couldn't possibly afford. Before you take out any loan, create a realistic budget that includes the payment. If you can't afford it, you should probably reconsider the loan.
Don't fall into the temptation of telling yourself that you will find some way to make ends meet. Instead, take care of securing any realistic extra income sources before you sign on the dotted line. Get a second job, line up freelance work, start selling stuff on eBay, or do whatever else you need in order to make loan repayment affordable. Just do it before you get the loan — otherwise, you're just creating more financial stress for yourself. And isn't that what the loan was supposed to solve?
2. When Your Purchase is Essential
Loans are never a good idea when you're using them to finance a lifestyle that is beyond your means. If, however, you find yourself in a place where you absolutely must have something essential (no, a remodeled kitchen or a tropical vacation are not essentials), and you can't afford it, a loan might be a good idea.
Again, I'm talking basic essentials here. If you have to drive to work, you must have a functioning vehicle. If you live in a cold climate, you need a working furnace. Most of the time, these aren't purchases that can wait until you've saved the funds, and so a loan might be necessary.
3. When You Have Good Credit
If you have good credit (above a 720), you will most likely be eligible for lower interest rates on your loans. This means that you will pay less over the life of the loan and that your individual payments will be lower than they would be if your credit were poorer. And having good credit is, in itself, an indicator that you're probably capable of managing your debt effectively.
Having good credit makes loans a lot more affordable. But once again, make sure you can make those payments! Otherwise, you'll ruin that solid credit score.
4. When Interest Payments Are Less Than Your Investment Returns
Many investors think that they should use money from their investments to make major purchases before considering a loan. While this is sometimes true, it's also possible that it'll be better financially to leave your investments untouched and get a loan to cover the purchase instead. As an example, if your portfolio generates 10% annual returns, but a loan's interest rate would be only 4%, then it doesn't make sense to lose that extra 6% in returns that your portfolio's funds are generating.
If the rate on the loan is lower than your rate of return and you can make the loan payments, take the loan and keep your money invested. On the other hand, monies from your portfolio might be a smart source of cash for re-paying very high interest loans, such as credit cards. Never touch your emergency fund, though — that's the money you'll need for true emergencies, and unless you're facing bankruptcy or legal action, high interest debt isn't quite a true emergency that warrants depleting your safety net.
5. When You Can Pay it Off Early
Sometimes you know there's money coming in, but you just don't have it yet. If you need to make a major purchase before that money arrives, you can take out a loan and repay it as soon as the funds hit your bank account.
But if you're taking this approach, be sure that your loan doesn't have any prepayment penalties. This strategy can work well for people who get large bonus or commission checks on a quarterly or yearly basis, so long as you don't overestimate your actual earnings.
6. When You Qualify for a "Special" Loan
There are a lot of "special" loans on the market, most offered by different government programs for things such as home-buying, education, or energy-efficiency retrofitting. These loans typically offer very favorable repayment terms which often make them worthwhile.
For example, FHA loans, VA loans, and even USDA loans can help people buy homes who might not have qualified otherwise. My husband and I bought our house last year using his VA loan, which saved us tons of money on the up-front costs. Without it, we'd have been hard-pressed to afford the house.
Taking out a loan is something that a financially responsible person might never want to do. However, sometimes loans are necessary to meet our larger goals and, in the above cases, they may not be such a bad idea.
What have you bought with money from a loan? Do you think that getting the loan was worth it?
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