Pros and cons of taking a personal loan to cope with rising cost of living
Obtain relief against stress and anxiety
Interest charges and other costs of borrowing means you end up paying more money over time
Allows you to maintain your current lifestyle (or at least minimise disruptions or changes)
Locks up your cashflow for the duration of the loan
Avoid late charges and penalties, which can quickly add up
Reduces maximum mortgage amount, which can disrupt your plans for home ownership
Provides time to work on more permanent solutions (such as increasing your income)
Opportunity cost; paying off debt instead of saving/investing
Benefits of taking a personal loan
When bills pile up and your income is barely able to keep up with your everyday expenses, the stress and anxiety that results can take a toll on your wellbeing.
One of the biggest benefits of taking a personal loan is the immediate relief of psychological pressure, giving you some respite and allowing you to regain a sense of control. This can be hugely important in helping you to manage a difficult situation.
A loan provides the funds for you to maintain your current lifestyle, or at least minimise disruptions and prevent having to give up too many things. This, again, is important for psychological wellbeing.
At the very least, taking a loan can provide funds to help you keep up with bills and other ongoing financial obligations, avoiding late fees, interest charges and other penalties. These can quickly add up, putting you further into debt, so it’s best not to incur any if at all possible.
Another benefit that should not be overlooked: A personal loan can provide you with the time needed to increase your income and/or reduce your expenses – whether that be changing to a higher-paying job, setting up a side hustle, or paying off debt.
Pitfalls to consider when taking a personal loan
Now, the most important thing to understand about taking a personal loan is that you are essentially borrowing from your future self. Let me explain.
You see, every dollar that goes towards paying off debt is one less dollar that you have to save for emergencies. Or to invest for the future – whether directly in a retirement fund, or indirectly, such as by picking up new skills and qualifications.
Thus, any decision to take a personal loan must be carefully weighed in the context of the opportunity cost that you are incurring.
Also, while the funds offered by a personal loan provides immediate benefits and relief in the face of a stressful situation, never fail to consider that you will end up paying even more money over time, due to the interest you have to pay on your loan.
During the tenure of the loan, a portion of your cashflow is locked up each month to pay for the monthly instalments. This means less freedom in your budget, and if your loan repayments are particularly large, may even see you left with little to no money for discretionary spending.
Another potential pitfall of taking a personal loan is that your home ownership plans may be affected. This is due to the Total Debt Servicing Ratio (TDSR), which is a debt-management initiative that limits the total amount paid towards debt, including mortgage, to 55% of gross monthly income.
Hence, depending on your existing debt obligations (this includes all forms of debt, such as credit card balances, education loans, car loans, etc), taking a personal loan may leave insufficient “quota” in your TDSR, preventing you from taking the home mortgage you need.
How to use personal loans responsibly
Personal loans can be beneficial, but they also present some potential pitfalls. The key is to be aware of what you are getting yourself into when applying for one. Here are some tips that will help you use personal loans responsibly.
Ensure you can meet the monthly instalments
The most important factor when deciding upon the terms of a personal loan is how much you have to pay each month. You should err on the side of caution and choose a lower instalment amount that you can easily cope with, even if you have to stretch out the loan tenure longer.
This is because you can always pay more into your loan in the months you have extra cash; any extra payments will accrue and help you pay off your loan faster.
On the other hand, if you choose too high an instalment that you can’t meet, you will be slapped with late fees and have to pay extra interest on overdue amounts, which will drive up the cost of borrowing and make your loan more difficult to pay off.
Also, be aware that restructuring your loan to lower your instalments will incur an admin fee, which means you’re paying even more money on your loan.
Borrow only what you need
It can be tempting to take a larger loan than you need; since you’re already borrowing, you might as well secure some extra funds as a buffer, right?
This mentality is not as harmless as it appears. Consider that interest is charged on the entire loan amount, so you’re basically paying extra if you borrow more than you need.
Also, if you find yourself having this mentality, you might want to consider if you’re taking personal loans (and by extension, other forms of unsecured credit, such as credit cards and lines of credit) too lightly.
Always remember the opportunity cost of having to pay back debt – it impacts not only the present, but also your future, and to a further extent that you might realise today.
One more thing; borrowing only what you need will also help keep your monthly instalments small, so you’ll have an easier time managing your loan overall.
Make up for the opportunity cost
When deciding whether to take a loan, you should also consider how you can make up for the opportunity cost.
Not being able to invest as much because you have a S$40,000 student loan to pay off becomes less of a problem when you’re able to graduate into a high-paying job that will allow you to invest more aggressively later on.
Similarly, taking a loan to ensure your family’s needs are met – so you can focus on building and launching your business – can be a decision that pays off when your enterprise succeeds.
Granted, it may not always be possible to make up for the opportunity cost of taking a loan. You may find yourself just needing an extra few thousand bucks to lock in your children’s enrichment classes for the year, and that’s ok.
Just remember that a personal loan is a temporary fix; use the time it provides wisely to work out a longer-lasting solution.
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