Can you afford a loan?
There are many reasons for wanting to afford a loan. You may need help will an unexpected bill such as your car or washing machine breaking down. You may need extra help to cover Christmas, birthdays or holidays.
Or you may wish to consolidate existing debts. Even if your credit is less-than-perfect there will probably be an option for you.
There are many factors that influence how affordable a loan is. Your income plays a major part in determining your loan amount. And the money you have going out each month determines the amount of money you have left over.
This is also called your disposable income. Calculating your disposable income is also a useful tool when budgeting your finances. Borrowing more than your disposable income can get you into serious repayment trouble.
Taking out a loan should ideally not impact on your lifestyle. If the repayments will mean making significant sacrifices then perhaps it is not a wise decision. Finally, your personality and attitude to money can affect if you can afford a loan. You should also consider non-financial factors like this when making a decision about how much you can borrow.
How do you actually work out if a loan is affordable?
First, you will need to work out your income. You should check your payslips or bank statements to get exact figures. You should also include any extra income such as rent from lodgers or other help. When working out your income you shouldn’t include any irregular or “one-off” payments.
Next, you should work out your outgoings. Look at all the bills you currently pay each month. These can include:
- Credit cards
- Utility bills
- Council tax
- Transport costs such as vehicle expenses (car tax, insurance etc.)
- Mobile and home phone bills
- Student loans
- Personal savings
- Pension payments
- Childcare costs
Add them up and subtract the total from your monthly income. If your spending adds up to more than your income, borrowing money may not be suitable. This is especially true of short-term lending, which tends to have higher interest rates.
Borrowing money in this situation can lead to serious financial difficulties. If you have money left over at the end of the month, would it be enough to meet repayments? Are you sure of what those repayments will be?
Dividing the total repayment amount by the number of months only gives a rough estimate of the actual monthly payment. Don’t forget you’ll also have to pay interest which can vary each month because not all loans are the same or carry equal repayments.
You can check out our loan affordability calculator to calculate if you can afford a loan.
How do interest rates affect if I can afford a loan?
The borrowing rate of your loan will vary depending on a variety of factors. These include the type of loan, the amount you borrow and the duration of the loan. If you have a very poor credit history you could be refused credit.
If you are accepted, the rate charged is likely to be much higher. Most important, the borrowing rate will vary greatly between lenders. There is a lot of variation even amongst short-term lenders.
Some will roll over most of the loan amount so that you can repay a lump sum at the end of the borrowing period. Others will divide your payments evenly. In general, the better the rate of interest, the stricter acceptance and affordability criteria you can expect.
If you have calculated that you can afford a loan, you may still choose not to accept it if the extra debt might reduce your credit score. The amount of total credit you have available compared to the amount you’re using is often a factor in determining your credit score. If a new loan will adversely affect this comparison it can also affect your credit score. This may mean that you could find it difficult to get additional credit if you really need it in the future.
Choosing an affordable loan
Even when you’ve considered your expenses and outgoings you can still find it difficult to keep up with your loan payments. It is important that you have a backup plan in place in case of financial emergency. Situations like car repairs can leave you struggling with repayments.
Most lenders will co-operate with you in situations like this to help you get back on track. Before committing to a loan it is, therefore, crucial to find out how flexible the loan terms are.
Finally, before taking out a loan you should decide whether you can afford a loan. You should ask yourself some simple, important questions. Do I really need this extra money? Are the repayments realistic? Would I still be able to afford the repayments if my circumstances change?
If you answer “yes” to these questions then a loan may be the solution you are looking for. If you are unsure about meeting the repayments then should not take out a loan.
And it isn’t just you who needs to decide if a loan is affordable. Lenders will also look at your circumstances to see if they think a loan is affordable for you. They take into account your income and outgoings. Your income is the money you have coming in, such as wages or benefits. Your outgoing are your regular payments such as rent/mortgage, utilities and other bills.
Are you able to keep up with payments?
By comparing what you have coming in with your living expenses, lenders will calculate whether you can afford a loan. A loan is considered affordable if you are likely to be able to keep up with the agreed payments. They can then decide to lend you the amount you’ve requested, a lower amount or not at all.
Loan affordability is an important factor when deciding to borrow, or lend, money. Always choose a product with realistic, affordable repayments. This way you can avoid financial difficulties. In the end, only you can decide if you can really afford a loan.
Lenders will review your credit report, credit scores and income when considering your loan application. But at the end of the day, you are responsible for deciding if you can repay a loan. If you decide you can afford the loan then it could also help you to build good credit. It is important to always make payments on time and keep your repayment in good standing.