Loans: Is A Loan The Right Choice?

Before you take the plunge and take out a loan you need to answer two simple questions.

The first is do you really needed to borrow all this money? Borrowing money is almost always an expensive business, plus it gobbles up a slice of your income that could be invested to build yourself a stronger future. It goes without saying that, wherever possible, you should aim to borrow as little as possible so you don't overstretch yourself and end up with a bad credit record. For example, you don't have to take out a car loan for a new vehicle every two years just to keep up with the Joneses. In the UK, sales of used cars exceed new-car sales by about three to one - and a quality second-hand car might be more up your street.

The second is have you considered the alternatives to a loan?

If you have savings then dipping into your savings is likely to cost a lot less than taking on the burden of borrowing even if it is a cheap loan. Borrowing rates are usually higher than savings rates so you stand to gain by having a smaller savings pot, rather than having all your savings alongside a shiny, new loan. What's more, by delaying your purchase and putting aside some spare cash for a few months, you stand to benefit even more.

Although having a fat cash cushion feels nice and secure, it may not be an efficient use of your money. If you decide to fund a major purchase from your savings, leave money in tax-free accounts, such as cash ISAs until last, as you cannot replace money removed from these accounts.

Another alternative is to make your purchases using an interest-free credit card, switching the debt to a new 0% credit card when the introductory period expires. Although most interest-free credit cards now charge a fee for balance transfers, paying zero interest on the amount you've borrowed is still likely to be a cheaper option than taking out a personal loan.

Finally, many people are tempted to go cap in hand to family or friends. On the face of it, this may seem like a good idea, as often no interest changes hands. But what happens if you cannot keep up your repayments? Think very carefully before taking this route. However, for a short-term loan, where you are sure to repay the debt in full, it makes sense if you have a generous friend or relative who is happy to lend you the money.

Next article: Consolidating Debts

Published on November 17, 2006