Most often, when people are shopping for loans, they only focus on borrowing the amount that their end purchase will cost. If I want to buy a $20,000 car, then I’m going to borrow $20,000. Makes sense, right? While this may seem like easy math on the surface, there’s actually a lot more going on, that you need to examine, before you determine how much you’re actually going to borrow. If you don’t, you may find that you’re borrowing far too little, or worse, far too much money, and that will leave you in worse shape than if you hadn’t taken out a loan in the first place.
Below, we’ll list some of the factors that many people tend to gloss over when they’re shopping for a loan, and give you some helpful tips to find the amount that’s right for you.
Determine Total Amount of Your End Purchase
As stated above, this is your starting point. You need to be aware of the total amount that you’ll have to pay out in order to afford your end purchase. It wouldn’t make any sense to borrow just $500 if you were trying to buy that $20,000 car.
But when I say look at the total amount, I don’t mean just the purchase price on your item or service. Depending on what you’re buying, you may need to take out an extra amount to compensate for certain factors. The car I keep referencing might need some basic maintenance or body work done. Another example might be a home renovation project, where it can be hard to determine exactly what the final amount will be.
When you encounter situations like this, you might be better off to borrow a little bit extra, just to prepare for contingencies. It might be well worth it to take out $22,000 against your car, just in case you do end up needing some additional maintenance done.
Ensure You can Afford the Interest
I believe most of us would have no problem borrowing exorbitant amounts of money, were it not for the interest rates. Fortunately, or unfortunately, depending on how you look at it, interest rates not only allow lenders to stay in business, but they help keep us in check about borrowing too much money. When it comes to determining how much to take out in a personal loan, much of your decision will be based on how much interest you’ll have to pay.
Obviously, the lower your interest rate, the more comfortable you can feel about borrowing larger amounts. Even if you took out a $50,000 loan, if your interest is only 3%, you’re only paying $1,500 in interest; that’s not too bad, in the grand scheme of things. Conversely, if you’ll be charged 15% interest on that same $50,000 loan, you’re now obligated for an additional $7,500. Quite a big difference for just a few percentage points, isn’t it?
That’s why it’s critical that, before you start shopping for a loan, you make every effort possible to get your credit score to the best it can be, even if, ultimately, it’s still considered bad credit. The better your credit score, the more likely you’ll be to receive a better interest rate.
Check the Life Cycle vs. Your Monthly Payments
One of the main draws for many people in getting a loan is that it makes a larger purchase more manageable. I’d wager that very few of us could afford to drop $10,000 on a whim, but making a $250 payment once a month could be very manageable. In the example of that last sentence, that $10,000 was spread out over three years, and before you decide on the final amount that you’re going to borrow, determine how long the lender is willing to stretch out your loan repayments.
In most instances, lenders understand that the bigger the amount you borrow, the longer you’re going to need to pay it back. I’ve never heard of a professional mortgage firm, for example, demanding that the entire mortgage is paid off in five years or less. Most mortgages come in either 15 or 30-year repayment cycles, and lenders understand that the high cost of a home means that people will need literally decades to pay it off.
Even when you’re looking at taking out a loan for a modest sum, you need to ensure you understand how long the lender is willing to extend the life cycle of your loan. Even a loan of $5,000 will cost you over $400 a month if you only have 12 months to pay it back, which may very well be more than you can afford to pay at one time. So, this is information is crucial to know, regardless of the amount that you’re taking out.
Determine if You Need to Fund Everything with Your Loan
With most any kind of purchase you make, if you’re taking out a loan, you’re going to shell out some level of down payment. Down payments are often key to securing big loans and purchases for several reasons:
- It proves that you’re committed to receiving the loan
- It allows the vendor to receive at least some of the money right now
- It means that you’ll be obligated for less interest on a lower amount
When you’re considering taking out a loan, you need to determine if you want to fund your purchase wholly with borrowed money, or if you want to split up the cost in some way, shape, or form.
A perfect example of this scenario would be a vacation. People frequently take out loans to fund a vacation, though very few fund the entire thing on wholly borrowed money. More often, people save up enough to afford anywhere from 25 to 50% of their total expenses and use a loan to fund the rest. When you’re finalizing how much money you want to borrow from your loan, first determine how much you can afford to fund yourself. You’ll be obligated for less money overall, and will avoid paying out an extensive amount of interest.