How to use personal loans and avoid falling into the debt trap
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There are many guides to getting out of the debt trap, but why don’t you think about avoiding it in the first place? One bad decision after another, and you are doomed to spend a lot of time and lose a lot of opportunities to get out of this debt hole.
We’ve compiled these recommendations to alert you to common mistakes and provide an example of responsible financial behavior. Follow our tips to reduce the risk of getting trapped if you have to use loans.
What is a personal loan
The name is clear: Personal loans are money received from a lending agency that you can use for personal purposes. Usually the amounts are much lower than in the case of business loans.
And the process of applying for and getting the money into your account is much easier. In some cases, the whole process takes less than 24 hours.
There are several classifications of personal loans based on various criteria:
Depending on the guarantees requested:
- secured loans need insurance in the form of valuables and valuables;
- unsecured loans do not require any collateral.
Depending on the purpose:
- vacation loans;
- wedding loans;
- consumer loans;
- debt consolidation loans etc.
According to the terms:
Depending on interest rates:
- fixed rate;
- revisable rate.
The main thing is the use of the money for personal and short to medium term purposes.
Why is it important to be careful when taking out a personal loan
Loans provide a tempting opportunity to get whatever you want right away. It is very easy to fall into the deceptive feeling of the availability of valuables. The gloomy outlook for debt repayment is not frightening enough.
Remember that when processing your request, the bank only considers your declared income and other debts. You can also find one of the online lending places only direct lenders provide financial support.
The other factors are not taken into account in the calculation. But what if you lose your job or take a pay cut? Will you be able to pay down payments on time? Pay attention to these factors when applying for a loan.
Credit cards require careful handling because it is extremely easy to accumulate huge debt through multiple small purchases. It is the same for small consumer loans, which can rise to a significant figure at the end of the month.
We recommend that you consider the worst-case scenario when deciding to apply for a loan. If you are still able to repay it, go for it. But when in doubt, it’s best to stop and find another source of money.
What are the personal loan requirements
The first thing every credit agency takes into consideration is your credit history and your score. In September 2020, more than 38% of U.S. citizens had a geo-credit score of A to E, which corresponds to a traditional credit score of at least 740. Only about ten percent had geo-credit scores of P to T (539 or less).
The second important factor is your income. According to this, the lender will calculate the maximum amount that you can receive. Many lenders do not state the minimum income they need to approve the application; this is normal practice, so don’t be surprised.
The bank may ask you for your tax returns or a bank statement to confirm the income you reported in the application.
The lender will also check any other debts you have and assess any collateral. Based on these criteria, the lender will approve or deny your application and calculate the interest rates and loan terms.
How the APR is calculated
The annual percentage rate is the amount of money you have to pay for the loan each year. It is calculated based on the total loan amount. This is a critical factor that increases the cost of the thing you buy, so you need to know the APR of your credit cards and the loans you use. For example, if your credit card’s APR is 12%, you’ll pay $ 120 per year for every $ 1,000 you borrow. Obviously, the lower the APR, the more advantageous the offer, if the other parameters are the same.
If the loan terms are less than one year, you can divide the APR percentage by 365 days. For the example above, the daily rate will be 0.03287. Multiply this rate by the amount you own and you will receive daily interest. In our example, that’s $ 32.87 for every $ 1,000 of debt.
How to be sure to pay off your debt
The best way to ensure your safety in unforeseen circumstances is to have an emergency fund that you can use to pay off the loan. Multiple sources of income can provide some level of security, as the likelihood that you will lose them all at the same time is lower than in the case of a single income.
Most importantly, we recommend that you implement meticulous financial management in your day-to-day life. Based on accurate information about your income and expenses, you can assess prospects and find ways to pay off debt.
Specialists advise to keep the total amount of debt at the level where the monthly payments are less than 30% of your total income. Otherwise, you will find yourself in a very difficult situation, and paying off will take a lot more sacrifice and effort.
Why the debt trap is so dangerous
The debt trap refers to the situation where you are forced to take out a new loan to pay off the previous one. Don’t confuse it with debt consolidation. The latter is a valuable financial tool, and the former is the result of poor financial decisions and unforeseeable emergencies.
The main danger of the debt trap is accumulating your debts. This strategy leads to a constant increase in monthly payments, and soon you will have to apply for another loan to cover the payments. So, if you are considering taking out a loan for this purpose, stop and think again. If there is another opportunity to get money, use it.
When you are trapped in debt, it is extremely difficult to improve the situation. So, turn around before you take the step into that hole.