The worst mistakes you can make when taking out a loan

Most of us have to borrow money at some point, whether it’s a car loan to buy a car or a mortgage to buy a house.

Borrowing can help you improve your financial situation if you are able to meet your payments. Loans can help you increase your equity and build your credit. But they can also become difficult, if not impossible, to manage if you make certain borrowing mistakes. Indeed, some mistakes you could make when taking out a loan could devastate your financial security for years to come.

If you take out a loan, you don’t want it to have a negative impact on your financial life. Be absolutely certain to avoid these three borrowing mistakes.

1. Borrow money you can’t afford to pay back

If you’re not 100% sure that you can repay a loan you’re considering taking out, just say no to the loan. Don’t expect your income to increase later. This could lead to major financial problems.

Missing a single payment could hurt your credit rating for many years. This could make each loan you take out more expensive or prevent you from getting the credit you need. And failure to repay a loan could cause a creditor to continue with their collection efforts. They could sue you and seize your wages or get a lien on your property.

If you’ve taken out a mortgage or car loan and can’t pay it off, you could end up with foreclosure or repossession – and you could lose the money invested in your home or vehicle. Your credit could also be damaged for a decade.

Always review your budget before borrowing and make 100% sure that your new loan payment is comfortably affordable. If you have even a shadow of a doubt as to whether you will be able to make repayments on the loan during the life of your loan, do not take out the loan.

2. Borrowing money at too high an interest rate

The higher your interest rate, the higher the cost of borrowing and the harder it is to repay your loan. This is because more of your money will be used for interest, so your principal balance will slowly decline.

You also agree to take on a large financial obligation, which could prevent you from staying on a budget or meeting other financial goals. Borrowing at a high rate also lowers your options in the future. You might not be able to move on to a job you prefer if you were to take a pay cut, for example.

Since getting the lowest interest rate possible is so important, shop around and get quotes from multiple lenders before borrowing. It pays to carefully consider the different loan terms and compare the rates of at least three lenders. You never know when a loan provider can offer significant savings over their competition.

3. Take a loan that you do not understand well

When you borrow, you should know:

  • Monthly payment
  • If your payment could go up, how often it could go up and what could trigger it
  • What would the maximum amount of your payment be if your payment increased
  • When are you supposed to pay off your loan in full
  • The total interest you will pay over the life of the loan
  • If you are subject to prepayment charges or penalties if you prepay or refinance the loan

If you don’t fully understand the terms of your loan, you could end up with an adjustable rate loan that becomes unaffordable down the road or a loan that requires a large lump sum payment. Or you could find yourself stuck in a loan that you can’t really afford and can’t get out of. And that could lead to financial disaster.

Many people ended up with mortgages they didn’t understand before the 2008 financial crisis, and millions have been foreclosed or nearly lost their homes because of it. While this is a particularly big problem with mortgages, you need to know the details of any borrowing you take out, even if you are just purchasing a credit card.

If you understand your loan, you can make an informed choice about whether it is the right financial decision for you.

Avoiding these mistakes is the key to financial success

If you can avoid these borrowing mistakes, you should be able to avoid serious debt problems. Your debt can be a tool that helps you achieve your goals rather than an albatross around your neck that makes money management impossible.