Can You Really Afford That Loan?

Getting approved for an auto loan or mortgage can seem like a dream come true. But that dream can turn into a nightmare if you find yourself unable to keep up with the loan payments. Before you sign any kind of financial agreement, it’s important to understand what will be expected of you, and if you’ll really be able to afford to repay the loan.

While many lenders will consider your credit scores when deciding to offer you a loan, it’s ultimately your expenses, income and the interest rate of the loan that will reveal whether you’ll be able to carry the monthly payment. Before taking on a new loan, consider these factors:

Your Current Expenses

Gather all the bills you currently pay each month, including credit cards, utility bills, groceries, vehicle expenses, mobile bill, rent, student loans, personal savings, retirement account, etc. Tally them up and subtract the total from your monthly income. If your personal budget is already in the red (spending more than you earn) you may reconsider whether you should take on additional debt. If you have money left over at the end of the month, is it enough to cover the costs of a home mortgage or new auto loan and all the additional expenses that can be associated with both investments?

Gauge the Interest Rate

Dividing the total amount you want to borrow by the number of months you’ll take to repay it gives you only a very rough estimate of the actual monthly cost of the loan. Don’t forget you’ll also have to pay interest, which will increase your monthly payment. Interest rates can vary widely, and if yours is variable it can even change during the life of the loan. It’s important to consider interest when calculating the true cost of a loan. The good news is, however, that a good credit score may give you more power to negotiate a favorable interest rate and payment terms with the lender.

Verify the Flexibility of the Loan

Even when you’ve carefully considered your expenses and monthly payments, you may still find yourself unable to cover the loan payments. It’s vital that you have a backup plan in place in case of a financial emergency, such as a job loss or significant car repair. Some lenders will work with you when you face financial hardships, so before you commit to years of payments, it’s important to understand how flexible or fixed your loan terms might be.

Consider the Credit Impact

Even when you really can afford a loan, you may choose not to accept it if the additional debt might adversely affect your credit scores. The ratio of total credit you have available to the amount you’re actually using is a factor in determining your credit scores. If a new loan will adversely affect your ratio – and your credit scores – you may find it difficult to secure additional credit if you really need it in the future.

In the end, only you can decide if you can really afford a loan. While lenders will likely review your credit report, credit scores and income when considering your loan application, you are ultimately responsible for determining your own ability to repay a loan. If you decide you really can afford the loan you want, be sure to seize the opportunity to further build good credit by always making payments on time and keeping your repayment in good standing.