Personal loans: The Good, the Bad and the Ugly Debt

Personal Loans, or money that is borrowed from a bank, institution, or lender as a lump sum, can seem an attractive option to finance purchases and investments. Unfortunately, personal loans present problems when it comes to repayments, and can create bad debt- putting unnecessary financial pressure on those who are already struggling to cover expenses.

Personal loans, to clarify, are classified according to in two categories, namely secured and unsecured loans. Secured loans are those that are attached to collateral, for example a house or mortgage, against the sum borrowed. An unsecured loan does not require collateral, but a higher rate of interest is charged on repayments.

According to an article entitled “Poll: 2009 could be worse” on Fin.24, Andy Gilder from justmoney.co.za stated that “The trend for the start of the year has shown a sharp increase in applications for personal loans and credit cards and it would suggest that people are looking for money to cover their debts and holiday indulgences…”

However, despite the financial assistance that personal loans can potentially offer to make up for overspending, the reality is that taking out a personal loan to finance commodity purchases is not a good idea. This is because as it can lead to bad debt and consequent credit unworthiness. Instead, opening a bank account and saving up for a coveted purchase on a regular basis is a much more effective, and risk free, option.

The same applies to taking out a loan to cushion your monthly expenses. Instead, you should be making an effort to live within your means, and take the time out to plan and set yourself a monthly budget is much more effective. The current global economic downturn is a lesson in frugality, and should encourage us to only buy what we need, and to reduce our reliance on credit and fluctuating investments.

In an article entitled “Don’t get caught in a personal loan trap”, an analyst at moneyfacts.co.uk stated that “…rising unemployment and a declining economic outlook have meant the risk of customers defaulting on unsecured lending has increased”. The result, according to the analyst, is that “…borrowers are paying a significantly increased rate than they were 18 months ago…”

The truth, especially considering rising interest rates, is that if you do not have enough money to cover all your monthly expenses, you certainly won’t have enough to pay back a personal loan. Another reason why personal loans are not always feasible is that they require a long term financial commitment.

For example, taking out a personal loan to finance a vacation can cost you more than double due to interest rates. Once again, the less than ideal state of the current global economy demonstrates that consistent income and the value of stock market shares cannot be guaranteed.

Therefore, personal loans are risky as they can potentially damage your future ability to obtain credit for legitimate loans. Since the introduction of the National Credit Act in South Africa, it has become imperative that bad debt is avoided in order to maintain the credibility of your credit record.

Source:

“Make the best pick from the array of personal loans” Available at: iseekloans.com [Accessed 6 March 2009]

Meakin, T. “When is a personal loan a bad idea?” Available at: helium.com [Accessed 6 March 2009]

Routledge, S. (2009) “Don’t get caught in a personal loan trap” Available at: myfinances.co.uk [Accessed 6 March 2009]

Sapa (2009) “Poll: 2009 could be worse” Available at: fin24.com [Accessed 6 March 2009]