Under the right circumstances, borrowing money can be a good idea. Mortgage loans, business loans, student loans, and car loans are forms of investment that can lead to a better financial future. Loans taken out to cover emergency expenses can prevent a difficult situation from becoming worse.
No matter the reason for taking out a loan, it is imperative to properly manage repayment or you could find yourself in a spiral of debt with a low credit score. With proper budgeting, automated payments, and paying off loans early when possible, you can manage your loans successfully.
How do personal loans work?
When you borrow money from a lender you agree to pay back the original amount you borrowed, known as the principal, in addition to interest.
Interest is expressed as a percentage of the principal and can be simple or compound. Simple interest is calculated based on the original principal, while compound interest is pegged to the current amount owed, including unpaid interest added during the lending process.
With the exception of short-term loans, like payday loans, interest tends to build up over the course of the loan lifecycle. In other words, if you can manage to pay off a loan before it’s due you could save money in interest payments.
Finally, some loans have additional finance charges to cover loan servicing costs, like loan origination fees. The full cost of a loan across a year is known as the annual percentage rate, or APR. It takes into account all costs associated with borrowing and presents them as a percentage of the principal.
How to budget your loan payments
While the pricing of a loan is often expressed on an annual basis, you’ll almost certainly have to make payments more frequently than that. Most personal loans are paid back in regular installments over a period of time that can range between months and years.
Installment loans tend to require payment on either a biweekly or monthly basis with penalties for late payments. Loans with a defined payment schedule will also be amortized, which means you pay off a portion of the principal with each payment.
If you don’t already have a budget, now is the time to make one. Create a spreadsheet or download a budgeting app to streamline the process. Some apps even have functionality that can input your transactions in real-time. Enter your monthly income and expenses. If your expenses are more than your income, you have a problem and you will need to find ways to cut costs or create other sources of income.
Before you take out a loan, you should input the loan payments into your budget. This way you can see how repayments may affect your day-to-day life.
What if I can’t fit loan payments into my budget?
Before applying for a new loan, research your options to find the best lending solution for your needs. If the options available will strain your finances, consider holding off on filling any loan applications. Raising your credit score can help you find better rates and loan offers.
If you need a loan to cover emergency costs and don’t have a friend or family member willing to help, you may not have a choice but to find the best loan available. The more familiar you are with your budget, the better you’ll be able to manage surprises.
Why should you automate payments?
One of the most important loan management rules is to make on-time payments. Late payments can not only result in fees, they can harm your credit score. This can hurt your ability to access affordable loans in the future.
Almost everyone has experienced the sinking feeling of their front door locking shut behind them while their house keys lay forgotten inside. Thankfully, the fintech digital lending future we live in has the technology to automate your payments so you don’t encounter the same feeling by missing a loan payment.
Some lending platforms allow you to set up automatic payments through your bank account. Others send notifications to relieve the anxiety of remembering to pay your bills.
What are the benefits of paying off your loans early?
The sooner you can pay off your debt, the less you’ll have to pay in interest. If you can find non-essential spending in your budget that you’re willing to forego for a few months, it could be a good idea to direct that money towards paying off your loan(s).
Ultimately it’s your life and your finances, and no one can tell you for certain what is worth giving up to get out of debt more quickly; but a little more money towards loan payments now could mean a much less stressful future.
Which loans should you pay off first?
Borrowers with multiple debts who want to pay them off early may wonder which debt to tackle first. There is no one-size-fits-all loan management system for which debt you should prioritize beyond the minimum payments. However, there are a few repayment methods to consider:
- The Snowball Method suggests directing any extra funds towards the smallest debt you owe. Once that debt is paid off, you begin paying off the next smallest one. This method allows some people to gain a sense of accomplishment that can motivate them to continue paying down their debt.
- In contrast, the Avalanche Method recommends directing extra funds towards the loan with the highest interest rate. While you may not get the satisfaction of closing out loans as quickly, you’ll save more money in the long run by reducing your interest payments.
- When it comes to credit cards, borrowers should aim to pay off their bill in full each and every month. Most credit cards have a grace period, which means that as long as you pay off your bill in full each month, you won’t have to make any interest payments at all.
What if you can’t make your loan payments?
Most of the advice we’ve offered about managing your loans assumes you have the money to make your payments. If you’re struggling to repay your loan, you’ll have to choose from a series of less than ideal options:
- The best option is to contact your lender. Let them know your difficulties and see if they’re willing to give you an extension or work out a deal. Many loan providers aim to offer a better customer experience than their competitors, so it doesn’t hurt to ask.
- If their customer support doesn’t offer relief, you may want to look into debt management or debt settlement.
- For borrowers with extreme financial hardship, bankruptcy may be an option. However, this should be considered a last resort because it will cause serious harm to your credit.
The bottom line
Financial emergencies can take you by surprise. By properly managing your loans, you’ll have a better chance of maintaining a healthy financial life.
