It seems that people are getting loans all the time — for homes, cars, college, house renovations, even new business ventures. Borrowing money can be great when you need an immediate infusion of cash, but it doesn't come without risks. Check out some of the following dangers associated with borrowing money.
1. High Interest Payments
When you borrow money, you are obviously required to repay the original, or principal, amount back, and in nearly all cases, you pay more than that. There will also be interest, meaning you eventually pay for the lending service. You may get a low rate (or for some balance transfer credit cards, a 0% interest rate), but interest rates often make borrowing an expensive move. Rates change regularly so you want to borrow when there is a favorable borrowing market. And, of course, it is usually better to use your own savings rather than going into debt.
2. Credit Damage
Each time you decide to borrow money, you risk damaging your credit score if you don't repay as agreed. But if you make on-time payments, a loan or credit card can be a credit builder. And your credit score impacts many other aspects of your financial life. It can affect your ability to get future loans, the rates you secure on those loans, whether you can rent your dream apartment and more. It's a good idea to check your score and work toward improving it. (You can get a free credit report summary, along with two credit scores, updated monthly, from Credit.com.)
3. Strained Relationships
While you're more likely to get a better deal from a friend or family member, taking a loan from them can lead to a number of awkward situations. It can get difficult for the person to ask for the money back and you may feel a slight sense of guilt or obligation each time you see the "lender." While this method can help you secure a lower rate, it's a good idea to have clear rules and a written agreement around any exchange of money. And as much as you can, it can help to stay in touch about other things so your relationship doesn't get reduced to just a financial transaction.
4. Feeling Stuck
Taking money from a lender requires signing an agreement and making a commitment to pay a certain amount back each month. After that it's important to make your payments on time. This means even if you borrowed money for something years ago and your needs and desires have changed, you still have to continue payments until the balance is paid in full. Having these obligations can make you less attractive to new creditors and potential investors in the future, depending on what the loan type is. Be sure you can handle the life of the loan before you sign on the dotted line. Refinancing is an option in some situations, but it won't eliminate your debt, just restructure it.
5. Less Flexible Budget
Lastly, owing money to a lender will impart cash flow limitations on your future income. Over the designated term of your repayment period, you are assigning a certain amount of your money to repaying your debt. The funds may seem essential at the time you start your loan, but you are effectively eliminating part of your future proceeds or earnings during the repayment period. You don't know what you may need this cash for in times to come. If you take a loan, budget the minimum repayment amount into your budget and check regularly in case you can up the payment to end this cash flow limit once and for all.
Whether you turn to a friend, family member, bank or another financial institution, it's important to be aware of the implications of your borrowing money before you start.
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