Five things to consider before you take out a loan

People get into debt for various reasons. Before you take out a loan, here’s what you need to think about.

‍1. Know the difference between good debt and bad debt

‍Good debt helps you acquire things that build wealth or increase your income over time. Some examples include a home loan (if the home will increase in value over time), a car loan (if it will enable you to earn more by having your own transport) and a student loan (if it will help you get a better-paying job).Bad debt comes in various forms, like store cards, credit cards (if you don’t pay them off in full each month) and any other short- to medium-term loans. This debt pays for items that don’t increase your net worth, like clothing and food. Avoid it! You’ll be worse off financially due to interest and fees on the account, and there’s a risk of falling into a debt trap where you need to take out new debt to repay previous debt.

‍2. Compare costs

‍Debt in South Africa is regulated by the National Credit Regulator (NCR) through the National Credit Act. The NCR determines the maximum fees and interest, plus the maximum credit life insurance that can be asked. The interest rates are based on the repo rate plus a percentage. Rates and fees are adjusted from time to time. If you apply for a loan, you’ll receive a pre-agreement and quotation, both of which are valid for five days. The quotation will specify the exact cost of the loan. Too expensive? Shop around! Here’s how the fees work for a typical loan – you need to consider all of them to work out the total cost:Loan value (how much you borrow)  + Once-off initiation fee + Interest + Monthly account fee + VAT + Credit life insurance

‍3. Only borrow what you can afford to pay back

‍This sounds logical but so many people get stuck. If you don’t repay your loan instalments on time each month, you’ll have to pay additional fees and interest. Late payments will also negatively influence your credit record – not to mention the stress of creditors phoning you for money!Remember, you don’t need to prove your success by owning material things. The legendary US investor Warren Buffet has been living in the same house since 1958.

‍4. Pay it back as quickly as possible

‍Try to pay a little bit more each month towards your loan, over and above the minimum amount. This requires discipline but it will dramatically reduce fees and interest in the long term.

‍5. Avoid unplanned debt

‍Plan ahead. At the beginning of each year, note the big expenses that you’ll have to pay, like school fees and bond repayments, and save for them each month. Use 22seven to budget and you’ll soon find ways to save even more, without having to take on bad debt.Savvy savers will also recommend building an emergency fund for life’s whoopsies. You can use this fund instead of taking out a loan if you need to pay for something unexpected like getting a new washing machine or having your car repaired. Just remember to top up your emergency fund again afterward.