Personal Loans: Effective Financial Management Tool

July 03, 2015
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By: Kurt Schindler

With spending power comes great discipline.

When you need cash and you do not want to use your own, the next best thing might just be a personal loan. Yes, you may want to read that first sentence again but it says what you thought it says. Like all financial decisions, you can’t just jump into using financial products without first understanding if it’s right for you.

Managing your finances takes some skill, some knowledge, some daring and some help. When deciding on a personal loan you need to be very clear about why you need the money. There are costs and benefits to personal loans. Before you even begin looking at financing options, consider these pros and cons.

Top 3 Reasons on the upside

Hold on to your own money. When you use a personal loan, you do not need to empty out your bank account so your money stays working for you. This may enhance your feeling of financial stability because you have money in the bank. At your discretion, just in case you need it. This is a good feeling.

Don’t have to wait (to save up) to have the money. When you take out a personal loan, the money is ready for you to spend immediately. You don’t need to put off a purchase while you save up the money. You apply, get approved, and receive the money. Another way to save money is by obtaining a loan that has a lower interest rate than you are currently paying. If you can refinance a loan and lower the amount of your monthly payment, you will save the difference.

The more you borrow (and repay) the better deals you get on interest. The way the credit system works is that when you borrow, and show you are responsible by repaying the loan within the stipulated time period, you are a good customer. More lenders will be willing to lend you money in the future. Each time the interest rate should be among the best available. This strategy can also help boost your credit. There are several types of credit, and, to the eyes of the lender, it’s an indication that you not only have a credit story but you also have experience with more than one type of credit. If you don’t have experience with auto, mortgage, or student loans, this could help you create some interesting credit history for future lenders.

Top 3 Reasons on the downside

Money costs money. When you borrow, the bank is going to want you to pay it back with interest. After all, when you borrow, you are using someone else’s money. Whoever lends you money needs to cover the opportunity cost for the time you had the money. The other risk to the lender is that you might not be able to repay the full amount.

Future payments are known, future income is not. When you borrow money, the repayment schedule is known and you actually agree to make payments in the future, on specific dates. Unfortunately, income is not fixed or guaranteed. So we match a fixed payment with flexible income. Usually this works out ok, but there are times when income is subject to changes.

The more you borrow the more lenders want to lend you. If you have fairly unlimited access to capital, you might be tempted to borrow more than you actually need. You might begin to create needs because you know you can get the money and pay it off over time. Access to funds does not mean you have to borrow. You can when you need to but don’t overdo it.

Applying for a loan to manage your finances makes sense if you know how to do it. Understanding the need for a loan is a must and you should think and plan ahead in order to be successful financially. You must consider how a loan fits your financial goals, when is the right time to get one and more importantly if you can afford it. Since this should be a well thought out decision I invite you to read this article again and decide for yourself.

 

Kurt A. Schindler is the director of Financial Education at Banco Popular de Puerto Rico. He is a Certified Financial Planner® and holds a PhD in Personal Financial Planning from Kansas State University.


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