HomeFinanceCan You Really Afford That Loan? A Step-by-Step Guide to Find Out

Can You Really Afford That Loan? A Step-by-Step Guide to Find Out

Most borrowers think about emergency loans in terms of how it can solve the immediate issue of an unexpected expense they can’t afford. But what happens after the dust settles? Can you handle paying back what you use, plus fees?

Paying interest and finance charges on borrowed money is just how it works to borrow cash online or in person. Depending on your credit history, these fees may add a lot to your price tag. 

Still, these costs may be worth the relief an emergency loan provides. Read on to learn how to decide if you can really afford a line of credit or loan.

Step One: Understand the True Cost of Borrowing

Practically zero loans come for free. The majority apply interest and other finance charges to your principal, which is the amount you borrow. 

You should be able to find these details on a lender’s website. This way, you can shop around to compare the line of credit interest rates before you apply. If a lender doesn’t share these details, don’t bother applying.

Once you find a lender and loan you think will work, you’ll also find the cost of borrowing in your loan contract. Look for these elements in the fine print:

  • Interest rate, and whether it’s fixed or variable
  • Annual Percentage Rate (APR) 
  • Monthly scheduled payments size, if borrowing an installment loan
  • Payment schedule
  • Minimum payment details, if borrowing a line of credit
  • Any late fees and similar penalties
  • The lender’s policy on early or pre-payments

Step Two: Compare the Cost to Your Budget

Interest, finance charges, and monthly payments won’t mean much without the context of your budget. You need to know if you can handle these fees according to your lender’s schedule.

Take the time to dust off an old budget or make one from scratch. Take note of your take-home pay and your usual monthly expenses. Whatever is leftover is what you have to put towards your repayments. 

Of course, your budget may not be able to accommodate a new bi-weekly or monthly expense perfectly. You may have to sacrifice some non-essential, discretionary spending to free up cash. That’s normal. What isn’t normal is putting essential bills on hold to repay your loan.

If you can’t juggle all your basic needs and financial obligations with your new repayments, this isn’t the option for you. Go back to shopping around to see if you can find more affordable rates or borrow less. 

Step Three: Check Your DTI Ratio

DTI stands for debt-to-income ratio, which lets you know how much of your income goes towards debt every month. You might have a good idea of this number already after making your budget, but this calculation can help put your finances in better perspective.

To find this ratio, add up all your monthly bills. This sum should include rent or mortgage payments, personal loans, and other credit. Divide it by your total monthly income.

Generally speaking, your DTI should not be higher than 43%

Does adding this new loan to the mix push you over a limit?

You may still choose to borrow in an emergency, but know that the higher your DTI is, the greater financial risk you face. You’ll have less expendable cash to deal with other emergencies until you pay off debt. 

Go through these steps any time you want to borrow money. They’ll help you decide if taking on debt is worth it. 

I am Content Writer . I write Technology , Personal Finance, banking, investment, and insurance related content for top clients including Kotak Mahindra Bank, Edelweiss, ICICI BANK and IDFC FIRST Bank. Linkedin


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