4 Scenarios Where Taking Out A Loan Is A Good Idea

To some people, loans have a bad reputation as it puts people at risk of falling into a downward spiral of debt. However, loans come in many forms and amounts, and not every one leads to a bad result. In fact, taking out a loan can be a smart and strategic move if done as an informed decision.

It is crucial to learn how to decide when taking out a loan is a good idea, and when it is not. Familiarising yourself with the various options such as business loans and personal loans can also help you when you need to make a choice.

When are loans a good idea?

  • When the returns are more than the interest

Remember, with any loan, you will need to pay it back. If you borrow a large sum, you need to ensure you have the means to service the loan down the road. For business purposes, you might need a huge capital to start out. When deciding if it is worth it, ask yourself if you think your business can earn you back the loan amount, and more. If you are confident, go ahead and take out that business loan.

  • When making a big-ticket purchase

Sometimes, you need to finance some big-ticket items like a car, home renovations, or appliances. Even if you have enough money to fund it, it might not be a good idea to wipe out the bulk of your savings in one go. In these cases, you can plan strategically to use a loan first. While you may have to pay more eventually due to the interest, it can be a smart move as you preserve your own money as a buffer for emergencies, or channel some of it to investments – and potentially cover the interest incurred on your loan.

  • When you need to plug a cashflow problem

In between buying and selling off a home, many people meet with an issue of a lack of funds while awaiting payment from the property sale. There are many other cases you might meet with a cash gap as well – in these cases, bridging loans can help to tide you over a period of time while you wait for payment to be made to you. These loans are typically low-risk since you will expect to get back the amount in full anyway.

  • When you have other high-interest debts

If you already have debts on your credit card, or have a student loan to service, you can look into refinancing your debts with loans with lower interest rates. It may sound counter-intuitive to take up yet another loan, but the goal is to replace your existing loans with lower interest ones, so that you reduce your debt in the long run. When multiple loans are replaced by one low-interest loan, this is called a debt consolidation loan.

When not to take out a loan

While loans are quite readily available at licensed moneylenders around Singapore, this is not an excuse to spend beyond your means. It will not be wise to get a loan if you clearly don’t have the ability to repay it in time. Taking out loans to engage in high-risk activities is also dangerous as it can wipe out your loan quickly, and leave you without a way to repay it.

You can evaluate your own ability to pay back a loan by carefully considering the available repayment plans and your take-home salary. Most experts recommend a debt-to-income ratio of no more than 36% – this includes monthly recurring debts like house loans, student loans, and credit cards.

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