Borrowing money: considering the true cost.
Before you borrow money it pays to understand things like extra costs, how to avoid paying more in interest, and to consider what kind of debt you might be taking on.
What to consider when borrowing.
Borrowing money is a part of most people’s lives at one time or another. This could be a hire purchase on a costly item, vehicle finance or a mortgage on a home. Loans and credit can help when there is something that we need money for, but taking the time to save it isn’t practical. Borrowing money allows you to gain the benefit of your purchase immediately but it will cost more than in the long run than if you were to save. It’s really important to consider the full cost of borrowing before you make the decision to take out any debt.
What makes borrowing cost more?
Interest on the amount that you borrow is the most common cost of borrowing. This is paid along with each repayment that you make towards the loan.
There are other costs to consider however:
- A set-up cost or establishment fee.
- Late payment fees.
- Fees for paying the loan off early or making lump sum repayments.
- An admin fee for each payment that is processed, or even a monthly admin fee.
- A lump sum payment penalty.
It’s important to note that costs such as these must be clearly highlighted and brought to your attention, so remember to carefully read and understand this information before agreeing to borrow money.
Consider other costs related to your new item
For example, we may be able to afford to borrow money to buy a car, but what about the costs to register, run and maintain it? With the purchase of a home, don’t forget annual costs such as rates, water and maintenance.
Make sure to include all these costs in your budget before deciding if borrowing is the right thing for you – it might be better to hold off and save for a larger deposit, or until you can pay for the item in full.
The best ways to reduce the cost of borrowing
The term of a loan is how long it will take to repay when making the minimum repayments. Longer-term loans with lower monthly repayments will reduce the amount you have to pay each time, but remember the longer you have the loan the higher the overall amount you’ll pay.
Choosing a shorter loan will mean that you pay more each repayment but will save on interest costs in the end. You can also try to pay more than the minimum amount due each month, which will effectively shorten your loan term and save on interest costs.
It is important to note that it is often better in the long run to pay down any debt you have before starting to save. This is because the interest paid on debt is often higher than what you would receive from savings. So, as long as you have enough to live and use for rainy day expenses, paying down debt faster can be beneficial.
Avoiding additional fees is another way to reduce the cost of borrowing. This can be done by:
- Making regular repayment on time to avoid late payment fees and penalty interest.
- Choosing lenders with no lump sum repayment or administration fees.
A list of questions to consider:
Before you borrow, run some numbers and run through these questions:
- How much do I really need to borrow?
- How much interest will I pay?
- What other charges and fees will I pay?
- How much will my repayments be?
- What is the minimum vs what can I afford to pay?
- What is the total amount that I’ll be paying back?
- Is there an interest-free period?
- What will happen if I miss a payment?
- Is my home or household goods being used as security?
- How long will I be paying back the debt?
- How often will I make repayments?
- How sure am I that I want to take on this debt?
Things you should know.
The opinions expressed in the article above are not necessarily those of Westpac and the content is provided for information purposes only. Westpac makes no representation as to the accuracy or currency of the materials, which are provided without taking your personal financial situation or goals into account. Westpac accepts no responsibility for the availability or content of any third party material to which this article may refer.