A loan makes it easier to finance many things in life, especially when a large amount of money is required. However, a loan should only be used for purchases and projects that are truly essential and cannot be postponed. In the following article, we will explain what a loan actually is, when it really makes sense to take one out, and what should be considered when doing so.
What is a loan anyway?
With a loan, the borrower enters into a contract with a bank or financial service provider, which makes a certain amount of money available to them. This sum of money is subsequently repaid by the borrower to the financial service provider in the form of monthly installments, with the borrower having to pay interest to the financier in addition to the repayment amount.
In which situations does a loan make sense?
A loan should always only be used for purchases or investments that cannot be paid for in one go, or to cover costs that cannot be met in any other way. For example, anyone planning to buy a property usually cannot avoid taking out a loan and should calculate the expected costs in advance using a loan calculator for real estate. However, there are a few other things that the borrower should consider before signing a loan agreement.
What should be considered when taking out a loan?
Before signing a loan agreement, the borrower should always first create an overview of their own income and expenses to find out whether they have sufficient funds available for repayment after deducting all costs. Anyone who regularly enters all income and expenses into a household budget book can even skip this step and still have an accurate overview of their own finances.
Any ambiguities regarding the content of a loan agreement should also be clarified in advance, and the contract should only be signed once all points have been resolved.
Borrowers who, on the other hand, aim to pay off old obligations by taking out a loan quickly find themselves in a vicious circle. Therefore, they should rather contact a debt counseling service so as not to run the risk of having to file for personal bankruptcy at some point.
What should be considered when choosing the loan term?
The term of a loan should always be chosen carefully. On the one hand, care should be taken to ensure that the monthly installments do not place too much of a financial burden on the borrower. On the other hand, it is important to repay the borrowed amount as quickly as possible.
However, since the interest charged for most short-term loans is comparatively high, the term should be at least one year and, in the case of higher amounts, should be between one and three years. In this case, the borrower benefits from an excellent mix of loan amount and term, which helps to repay the borrowed amount more easily.
How useful is residual debt insurance?
When taking out a loan, the borrower is usually also offered so-called residual debt insurance, which secures repayment in the event of an unforeseen default.
However, such insurance, which takes effect in the event of job loss, incapacity to work, or death, is generally not worth it for most consumer loans. This is because such insurance significantly increases interest rates, and these insurance contracts usually contain numerous exclusion criteria, meaning that repayment is not automatically guaranteed even in the event of an insured claim.
For this reason, residual debt insurance only makes sense for large amounts with a long term. For example, in the context of financing a property.
