Most people don’t pay their college tuition with an upfront cash payment. The same is typically true for those who buy a car or a home. Instead, they borrow the money to make these large purchases and repay it over time.
If you can learn to manage your debt and not borrow more than you can afford to repay, a loan can provide financial flexibility in your life. This is true whether talking about instances of borrowing big, such as the previously mentioned examples, or when discussing smaller online installment loans taken out to cover things like car repairs and home improvement projects.
Money Management Best Practices
When determining how much money you can afford to borrow, look at your budget to see how much money you make per month. Then compare that to your current expenses such as a rent payment, student loan payment or any other money owed to a lender each month.
Ideally, you won’t spend more than 28 percent of your income on debt and other expenses. Therefore, if you make $3,000 a month, you don’t want a debt load of more than $840 per month. However, being a responsible borrower means looking at more than the monthly payment when assessing if a loan is worth taking.
You should also consider the interest rate, if the lender charges document or other fees and if there is a prepayment penalty. If there is, you won’t be able to refinance the loan or save money on interest by making multiple payments each month.
Loans Help to Build Your Credit History
One of the benefits of loans is that many of them can be used to build a positive credit history. This history and resulting high credit score may help you to save money on a variety of products. For instance, those with good credit generally pay less for insurance and may not have to make a down payment when leasing or buying a car. Individuals who have good credit are also eligible for lower interest rates on car, mortgage and other types of loan products.
Use Leverage to Grow Wealth
As a general rule, money kept in a brokerage account will grow by about 7 percent annually on average. Your annualized return can grow to about 11 percent if you have dividend stocks. The average interest rate on a car or home loan is about 3 to 6 percent for those with good credit.
Interest rates on personal loans are somewhere between 4 and 6 percent for borrowers with a credit score of over 700. If you don’t have to make a large down payment to acquire an asset, more money is left inside of a brokerage account where it will enjoy compound growth.
Over the course of 30 years, your portfolio will be worth substantially more than what you paid for your home or other assets even when accounting for interest paid to the lender. Essentially, you are using the bank’s money to help grow your net worth, and this is all possible because you were good at managing your debt levels.
By managing your money in a responsible manner, you can build wealth and gain the flexibility to borrow funds if you are in a financial bind. If you need help increasing your fiscal literacy, you can speak with a financial adviser or look for helpful resources online.