Sometimes you just need to buy something, but you don’t have the funds available to complete the purchase, so you have to borrow money. It’s a fact of life — and one most people will likely face.
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After considering the expertise of banking experts and financial advisors, one thing becomes clear: Bank loans can be either a powerful financial tool or a path to trouble, depending on how you use them. Here’s what the experts say about borrowing wisely for those big-ticket items.
Know Your Credit Score First
Before even considering a loan, check your credit score. A higher score– usually above 720 — means better interest rates and terms. If your score needs work, consider waiting a few months to improve it before applying. Even a 50-point increase could save you thousands in interest.
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Calculate the True Cost
Don’t just look at monthly payments. Factor in the total interest paid over the life of the loan, any origination fees and potential prepayment penalties. A $20,000 loan at 7% interest over five years will cost significantly more than the purchase price.
Follow the 20/10 Rule
Financial experts recommend keeping all monthly debt payments, excluding your mortgage, under 20% of your take-home pay — and don’t take on a loan that would require more than 10% of your monthly income for payments.
Choose the Right Type of Loan
Different purchases require different loans. These are some of the most common:
- Home improvements: Home equity loans or HELOCs
- Vehicles: Auto loans– usually lower rates than personal loans
- Major appliances: Personal loans or store financing — compare carefully
- Business equipment: Business loans or equipment financing.
Consider the Timeline
Match the loan term to the lifespan of what you’re buying. A 7-year loan for a computer that might last 3 years isn’t smart financial planning.
Conversely, stretching home improvement loans over 10-15 years might make sense.
Build in a Safety Net
Don’t borrow the maximum amount you qualify for. Leave room in your budget for emergencies and unexpected expenses. The best loan is one you can comfortably repay even if your income temporarily drops.
Shop Around Strategically
Check multiple lenders to find the best terms, but get all loan shopping done within a 14-day window. Multiple credit inquiries for the same type of loan within this period typically count as just one inquiry on your credit report.
Read the Fine Print
This one is important. You must pay special attention to several factors, including:
- Variable vs. fixed interest rates
- Early repayment penalties
- Late payment fees
- Automatic payment requirements
- Default terms.
Have a Repayment Strategy
Before signing, create a detailed repayment plan. Consider setting up automatic payments — many lenders offer rate discounts for this — and try to pay more than the minimum when possible.
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This article originally appeared on GOBankingRates.com: How To Use Bank Loans Responsibly for Major Purchases
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