Nothing can hurt your financial situation more than high-interest debt. Since the introduction of credit cards in the 1950s, consumer debt has been climbing steadily through time. With that being said, debt isn’t always a bad thing. Some debt, like mortgage debt, can be necessary to attain appreciating assets.
So, how do you figure out if you can take on more debt? This article goes over important questions to ask yourself and more. Taking some time to get organized and feel confident before signing off on more debt can help you avoid unnecessary debt and set you up for success.
Questions You Should Be Asking Before Taking on More Debt
If you’re already in debt in some way, shape, or form, it’s a good idea to consider the consequences if you take on even more debt. It’s important to keep your spending in check and only purchase things you can afford. Here are some questions to keep in mind when contemplating new debt.
Question 1: Is It Possible to Use Cash Instead?
Before making a serious purchase, you should always ask if it is possible to pay in cash. If the answer is no, you might want to rethink buying that particular item.
Maybe you really want to buy a new MacBook Pro or some expensive designer clothes. This is fine if you have the money and it doesn’t exceed your monthly budget for personal spending. But if you’re planning on buying these goods with money you don’t have using a credit card, the interest on those purchases could compound over time causing you to pay more than double the original price if it isn’t paid off quickly.
Making purchases you can’t afford can wreak havoc on your finances over time, which is why it is critical to ask yourself if you can afford any given purchase using cash.
Question 2: Will the Monthly Payments Be Affordable?
If you’re looking to make a major purchase, it is critical to be aware of the monthly payment. Try to not stretch yourself out too thin by taking on a high car, mortgage, or rent payments. If your car payment is 50 percent of your monthly salary, you might be allocating too much of your money to that, leaving you in a tough position to pay off your other expenses.
To combat this potential pitfall, create a monthly budget and stick to it. Map out where your money will go every month, and allocate a certain percentage of your income to each expense.
Question 3: Will These Payments Impede on Future Needs?
When thinking about taking on more debt, it’s important to consider how much is appropriate to spend on any given purchase. If you’re buying a new Peloton bike using financing and paying high interest on those payments, your physical health and stamina might improve, but you could also be putting your financial future at risk.
You should always calculate how any purchase can affect your future needs.
You might desperately need a new computer in the next year or so. Wouldn’t it be prudent to save a small percentage of your income over the course of that year to make sure you have enough to cover that expense in the event that your computer finally gives out?
Always consider how high payments can affect your immediate future. Calculate what a realistic and affordable payment is, and do not exceed that amount.
Question 4: Is the Repayment Term Favorable?
As you’re doing research for a possible new loan, consider the repayment terms and if they’re right for you. Oftentimes lenders offer anywhere from 3 to 18 months to pay off the loan.
If you’re contemplating taking out a $6,000 loan that has a repayment plan of 6 months, you would roughly be paying $1,000 each month plus interest charges. Whereas if the repayment plan was 18 months long, your monthly payments would only be $335 plus interest.
Remember to be realistic. While it may seem nice to have a large loan paid off in a few months’ time, the strain on your finances may not be worth it. The repayment terms matter and should be considered when taking on any new debt.
Question 5: Will the Purchase Last as Long as the Repayment Terms?
There are many purchases that can last a long time, but there are some that might not be able to outlast the amount of time it takes to pay them off. Take an older used car for example. Imagine taking out a high-interest loan on a 10-year-old car with over 100,000 miles for $5,000. This is definitely a purchase you should avoid.
Older cars have a high likelihood of breaking down and costing you even more money in repairs and maintenance. It is very probable that this purchase will not last as long as the 5-year loan you took out on it, making this a situation you should stay away from.
Always take into consideration the durability of an item, and whether or not it will outlast the repayment terms. If it has a high likelihood of not lasting as long as the loan duration, reconsider making that purchase.
Question 6: Are There Other Lenders Offering a Better Deal?
Whether you’re thinking about taking on a new credit card, mortgage loan, or auto loan, it is absolutely crucial to review multiple lending options. Oftentimes people run into the mistake of settling on the first loan rate they are approved for. Instead of settling on the first option, it’s important to take a step back and compare your offers.
It is recommended that you compare at least three different lenders when making a large buying decision. During this process, you can compare interest rates, financing options, repayment terms, and other variables that can save you time and money in the long run. Don’t be afraid to contact different lenders after receiving your first quote.
Question 7: Will This New Debt Hurt Your Credit?
When making a buying decision, it is essential to think about how taking on this new debt can affect your credit score. If the item is within your means and is something you can pay off quickly or right away, it should have a limited impact on your score. Also if you’re purchasing a home, your credit score may take a hit at first then increase as you make your mortgage payments on time.
On the other hand, if you’re buying something you don’t have the money for and already have high credit card debt, you should avoid that purchase. It can be easy to trick yourself into thinking that you can afford to pay certain debts off quickly when in reality it isn’t possible to do so. Making too many purchases like this can add up to thousands of dollars in credit card debt.
Different types of debt will affect your credit score differently. It’s important to take some time and research how your credit score may be affected before signing off on new debt.
The journey of financial wellness can be fraught with challenges. Don’t make it more difficult for yourself by not taking these questions into consideration. Always ask yourself if a purchase is absolutely necessary. If it is, make sure you can afford it. If you can’t afford it, think twice before taking on debt to get it.
4 Tips to Avoid Future Debt
In order to steer clear of debt down the line, here are a few tips to put into practice.
Tip #1: Avoid Credit Card Debt at All Costs
High credit card debt can become one of the most debilitating things that can happen to someone financially. It limits your ability to purchase a home or get approved for a car loan. And even worse, it can seriously prevent you from saving and investing.
Tip #2: Practice Restraint on Your Spending
Do not fall into the trap of high-interest debt and always take time in determining whether or not you can afford a serious purchase. While we can become seduced by our desire to spend on things we want, it is important to keep that urge to splurge in check.
Always ask yourself if you can afford to pay for any given purchase in cash, and if you do decide to finance, consider the terms of your monthly payment. Try to borrow money at low interest, and be sure to pay off your credit card balance every month.
Tip #3: Limit Your Debt
Take the necessary steps and limit the amount of debt in your life. If you remain vigilant in tracking your monthly budget while resisting the urge to overspend on unnecessary purchases, you will be able to keep your debt low and put the money you’re saving towards an investment or savings account.
Tip #4: Practice Makes Perfect
Attaining this level of discipline can be hard at first, but its difficulty isn’t remotely comparable to the financial devastation caused by high-interest debt. It’s important to pinpoint where you can improve and keep practicing positive spending habits. The more you practice, the easier it will become to spend within your means and improve your financial standing.
Takeaway
Asking yourself questions about debt while incorporating a thoughtful financial mindset in your daily routine will do wonders to your credit score, and will help you manage debt in a responsible way.
When taking all these questions into account any time you make a major purchase, it is undeniable that the process will change your finances for the better. By adopting the principles in this article, you will put yourself in a great position to see your finances flourish over time.
