Taking out new debt is not always a choice. However, if you’re not pressed by a medical emergency or an unforeseen disaster, it’s worthwhile considering whether you can actually afford it.
But what does it mean to “be able to afford a personal loan”? What percentage of your income should you not exceed dedicating to it?
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What percentage should you spend on a loan?
According to John White, COO of Bayport Financial Services, an average South African consumer currently uses 75% of their salary to pay off debt. Of those, 54% are currently in arrears and many experience financial distress and, therefore, are unable to save or plan for their future.
“A good ratio is your debt (including assets) should never exceed 35% to 45% of your nett salary (using your last three months income as an average gauge) minus your last three months’ expenses and debt repayments (again as an average),” says White.
However, he adds that this differs from household to household and personal circumstances. As a result, he recommends actively planning your finances in two distinct steps:
- First Step: Planning is done through a monthly budget based on your current monthly salary, showing your income, living expenses, and debt repayments. Then it’s important to check your bank statements and track previous months’ expenses to see actual spending. Within this, try to accurately estimate cash spending (and a really good way of doing this is to keep track of all cash expenses over a three-month period). This will then help you to determine what you can afford to pay off on your personal loan.
- Second Step: Determine your financial goals and your needs and wants. It is important to understand how a loan will fit into your current and future financial goals, and whether you will have sufficient funds to meet monthly loan payments without impacting on other necessary monthly expenses.
By following these two steps, you’ll be able to ascertain whether you can afford the monthly instalments for a personal loan. In addition, it will also help you get a grip of your general expenditure.
Nowadays there are also budgeting apps you can use to help you manage your money and keep track of how much you can truly afford. Have a look at this article about budgeting app, 22seven.
Good questions to ask yourself beforehand
White points out that being able to apply or qualify for credit does not mean you are ready to take out a loan. He adds that it’s important to be responsible enough to only take out debt which you can afford and know you can pay off regularly without being reminded.
Before taking out a personal loan, he recommends asking yourself the following questions:
- Why do I need the loan? Never apply for a loan so that you can repay your other debt. (this excludes a consolidation of debt loan that will help you reduce your monthly instalments by consolidating payments).
- Am I behind with payments on any of my debts? Again, this is a definite sign that another loan will not be a good solution.
- How often do I apply for loans and do I make use of loans to help me get through every month?
- Can I afford this loan (short-term or long-term), and will I be able to pay it back monthly after I have set money aside for potential emergencies?
- What is the potential of losing my income in the next 6 to 12 months?
- If you are forced to buy food on credit or use store cards (or pay for living expenses through loans) it is a sure sign you should possibly not apply for another loan but rather seek financial assistance.
According to White, the average loan amount is R35,000 and the average term is in the region of 50 months. He adds that Bayport loans are most often used for debt consolidation, education, home renovation, or for a deposit for a house.
In order to be approved for a personal loan, you need to have a good credit score. Register with Justmoney today to receive a free credit report immediately.