Taking out new debt is not always a choice, especially if you haven’t been able to save adequately. However, even in the face of an emergency, you still need to consider loan affordability.
What does it mean to be able to afford a personal loan? We offer some tips to consider before you go ahead.
Tip: If a personal loan is the right choice for you, click here.
What percentage of your income should you spend on a loan?
According to John White, COO of Bayport Financial Services, your debt-to-income ratio shouldn’t exceed 35% to 45%. You can calculate this by adding up all your expenses and debt, and dividing the total by your total nett income (including assets). You can use your last three months’ salary slips, expenses, and debt repayments as an average gauge.
However, White adds that the ideal ratio differs from household to household and according to personal circumstances. He recommends actively planning your finances in two steps.
- First Step: Plan a monthly budget based on your current salary, showing your income, living expenses, and debt repayments. It’s important to check your bank statements and track your previous months’ expenses to see your actual spending.
Within this, try to accurately estimate cash spending. A really good way of doing this is to keep track of all cash expenses over a three-month period. This will 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’s 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 repayments without impacting on other necessary monthly expenses.
In addition to assisting you to calculate loan affordability, these steps will help you get a grip on your general expenditure. There are also budgeting apps you can use to simplify this process.
Good questions to ask yourself beforehand
White points out that qualifying for credit doesn’t mean you’re ready to take out a loan. He notes that it’s important to be responsible enough to only take out debt that 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 other debt. The only exclusion to this is a loan to consolidate your debt, provided that it reduces your monthly instalments and offers a lower interest rate.
- Am I behind with payments on any of my debts? 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- 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?
- Am I forced to buy food on credit or use store cards - or pay for other living expenses using loans? This is a sure sign that you should not apply for another loan, but rather seek financial assistance.
According to White, the average personal loan amount is R35,000, and the average term is in the region of 50 months. These figures vary, but they give an indication of the length of financial commitment that a personal loan represents.