When to take out a personal loan

Ideally, you'd never need a loan. But life happens and sometimes you need extra cash to cover an unforeseen expense. Cars break down, pets get sick, and appliances sometimes need to be replaced. But this is where we have to be careful. It's all too easy to convince yourself that you need a personal loan for a certain purchase, when it would be wiser to put off borrowing money until you really need to. And that begs the question, when is a loan justified? Here, we look at five points that should be checked off before you apply for a personal loan.

Your purchase is essential

Essential expenses are those that need to be met for you to carry on living your normal day-to-day life. It's possible that you might need a loan to cover vehicle repairs or dental treatment not covered by your medical aid. But a new TV isn't essential, and when you take on loans for such expenses, you reduce your chances of qualifying for a personal loan when you really need it.

You're able to borrow only so much at any one time, and every loan reduces the likelihood that you will qualify for another. Before taking a loan, always ask yourself, is this necessary? There is a difference between buying furniture for an empty house and buying furniture to replace a lounge suite that has only just started to fade.

You intend to use the money to advance yourself

The greatest investment you can make is in yourself, and any money spent on training and upskilling is money well spent. When you know that a certain qualification or skill set will make you more employable, it can make sense to further yourself with a personal loan. But education and training aren't the only tools that you might use to progress yourself. If a suit helps you get a job, or an instrument helps you land a gig, such a purchase can also warrant a loan.

When Duncan Johnson had his saxophone stolen before an audition for a prestigious music school, he saw how easily his dreams could go up in smoke. Luckily, he was able to apply for a personal loan, and he purchased a new saxophone in time for the big audition. To read more about Duncan's story, you can read this article.

You have a good credit score

If you have a below average credit score (below 500 on the Delphi scale), you probably shouldn't be applying for another loan. But you shouldn't aim for just an 'okay' score either. A good credit score (720 or higher) would make you eligible for a lower interest rate, meaning that you would pay less over the life of a loan than if your credit score was lower.

A good credit score also makes securing a mortgage easier because it indicates that you are capable of managing your debt effectively. To learn how to improve your credit score, read our blog article on how to raise your credit score .

You are able to borrow from a responsible lender

There's a reason that some lenders will offer you a loan while others won't. Irresponsible lenders have no qualms about saddling you with crippling debt that they know you might not even be able to pay off. Their interest rates are high enough to ensure that if the odd customer defaults, they're still able to cover the cost.

When considering applying for a personal loan, just remember that bad-debt lenders will take their pound of flesh one way or another. If you can't get a loan from a reputable lender, reconsider how badly you need the extra money. To learn more about how to identify a responsible lender, read our blog, How to choose a personal loan.

You can easily afford the payments

This should go without saying, but in times of trouble, people can become desperate enough to take out a loan that they are unable to pay back. By only taking a loan from a responsible lender, you avoid taking on unmanageable debt, but you still need to adjust your budget so that you can see how much you'll be left with after your monthly payments.

Of all the boxes you check before applying for a personal loan, these are the most important: borrow only as much as you can pay back, and only borrow from a responsible lending institution. Institutions that offer quick loans and charge excessively high interest rates are not responsible.

Your interest payments are less than investment returns

Many investors choose to liquidate an investment before they consider applying for a loan. For example, some might sell their unit trusts to afford a certain expense. While this is an option, a personal loan might make more financial sense. If the interest rate on the loan is lower than your rate of return from your investment, it would be better to take the loan and leave your investment to carry on working for you.

Let's imagine that your unit trusts earn you a return of over 9% and that the interest on a loan was 7%. In this case, you'd lose more (2%) by selling your investment than you would if you took the loan. And, whatever you do, never touch your emergency fund unless it is for a real emergency. It's much faster to get money out of a savings account than it is to get a loan approved.

The risk is acceptable

Unlike credit cards, personal loans have to be paid off within a certain time period. If you fail to pay off a loan in this allotted time, a lender could take you to court and have you blacklisted. This would do serious damage to your credit score and make it difficult for you to apply for a home loan when you decide to do so. Read the fine print on the contract and be aware of the penalties for late payments.

Also, pay careful attention to the kind of interest rate offered. A promotional rate can start low (as low as 2 percent) but then jump to a higher rate after a certain time period. If you tick one of the first two boxes, and then check three, four, and five, a personal loan might be just the solution you are looking for. Just ensure that when you do apply for a loan, that it is with a responsible lender and that you've read the fine print.

As a financial institution that prides itself on its responsible lending, we at Old Mutual go out of our way to ensure that our customers understand the terms and conditions of their loans, thus ensuring that they avoid any unpleasant surprises. If you now want to know how to evaluate a personal loan, you can read our next article, How to choose a personal loan. Alternatively, if you'd like to learn more about Old Mutual's personal loans, visit our personal loans page.