Questions to Ask Yourself Before Taking on More Debt
Written by: Kristy Welsh
Last Updated: July 16, 2017
It seems that piling on debt happens very quickly and rather easily. Americans have more than $10 trillion in residential mortgage debt, more than $2.4 trillion in other loans, of which over half is student loan debt, $885 billion in credit card debt, all of which consumers are paying an average interest rate in excess of 13 percent. These statistics seem to suggest Americans collectively may be borrowing a little too much money and borrowing is a little too easy. So, before you borrow any more money, you should be asking yourself these tough questions before you take on any more additional debt.
Can You Use Cash Instead?
The answer to this question will largely depend on what you are trying to purchase and how much cash you have on hand. For smaller purchases such as clothes, small appliances, vacations, or other luxury items, you need to ask yourself if you can pay cash for these items instead of adding this purchase to your already overextended credit card or line of credit. Do you really need to buy it and if so, are you willing to plunk down the cash for it. If so, then it is worth buying. If not, then skip the purchase as it probably is not a truly needed item and one which would be better off forgetting until later down the road. If you can't pay cash for it, you probably really don't need it.
Is This the Most Cost-Effective Type of Borrowing Available?
Before taking out a loan on a large purchase, you need to make sure you are using the best borrowing vehicle available. In simple terms, is it cheaper (as in lower overall interest paid) to put the purchase on your credit card or to maybe use a home equity loan. If your credit card has a current interest rate of 22 percent but you can get a home equity loan for 10 percent, the choice seems a bit obvious don't you think?! Make sure to check out all avenues of borrowing before you make a large purchase, it will save you thousands in interest over a few years.
Are You Getting an Ideal Repayment Term?
Shorter loans typically carry lower interest rates. However, if a longer mortgage or car loan leave more room in your budget to avoid charging so much on your credit card, you might be better off because mortgage and car loan rates are usually much lower than credit card rates.
Will the Monthly Payments be Affordable?
Never borrow without taking a careful look at the repayment schedule, and knowing how you will come up with the money for those payments. The best way to know whether or not you will be able to make these payments every month is to work up a monthly budget. Listing out all of your monthly expenses and then deducting that from your monthly net income will show you in black and white how much money you have left over and if you can afford these new payments.
Will These Payments Crowd Out Future Needs?
Answering this question may take a little forethought and planning on your part first. For example, before you purchase the latest and greatest flat screen television are you anticipating purchasing a refrigerator or computer in the near future? If so, buying the TV may not be the best thing to do at the moment when you know you are going to have another large purchase coming very shortly.
Will the Item Last as Long as the Repayment Terms?
Avoid debts that will take longer to repay than the useful life of the purchase. A great example of this is buying a used car. Would you really want to put 5 year loan on an older used car that might not last you 5 years? Because if the car dies after 3 years, you are still responsible for 2 more years of payments on a car you are no longer driving. Doesn't really make much sense, does it? Think long and hard about the useful life of the purchase and does it make sense to the length of the loan terms.
Will This New Debt Hurt Your Credit?
As we have gone over in other articles, the amount you owe determines 30 percent of your credit score. So, the more you borrow, the lower your score, the higher the interest rates you are going to be offered. Bottom line, heavy borrowing can be made more expensive if your low credit score is raising your interest rates, which in turn higher interest rates make debt more difficult to pay down.
Are There Other Lenders Offering a Better Deal?
The financial industry is very competitive so you should always get multiple quotes on loans and shop around for the best interest rates. Bank and credit card companies have invested heavily on loan and credit acquisitions and the ability to make the process as easy as possible for us consumers. Because getting credit can be so easy, don't fall into the trap of settling for the first loan and/or rate quote that comes your way. Make sure to get at least 3 other quotes so you can compare loan products and get the best one for your situation.
Answering these question truthfully and honestly with yourself will go a long way in lessening your overall debt. Getting into debt can be fairly easy, but getting out is the hard part. Don't let yourself fall into the trap of heavy borrowing because you might not be able to get out from under it.