Are you constantly taking out loans, thinking it's the solution to all your financial troubles? Well, they might not be. Loans can be a valuable tool for managing finances, but it's essential to understand the potential consequences of taking out multiple loans or using loans for the wrong reasons.
When faced with financial challenges, it's not uncommon for people to turn to loans as a quick solution. However, relying solely on loans to solve financial problems can lead to the taking out of multiple loans, or what is sometimes referred to as "loan stacking."
Loan stacking involves taking out numerous loans or accumulating debt to cover expenses, potentially leading to worsening financial struggles. To avoid loan stacking, you should make informed decisions about loans and develop a debt repayment plan.
It's important to remember that loans are not a one-size-fits-all solution to financial problems. While they can be a valuable tool when used for the right reasons, taking out multiple loans to cover expenses can quickly lead to a buildup of debt and financial stress.
This article will explore the unexpected consequences you face when you take loans, thinking it will stop your financial problems, and what you can do instead.
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While taking out loans may seem easy, it's essential to understand that loans may not be the best option for resolving financial difficulties. Taking out loans can often lead to more problems in the long run. Before you take any loan, it is first important to understand the difference between bad and good loans.
Good loans help you build wealth and generate income. They have a way of repaying themselves, you can afford them, and it has future value. They include HELB, mortgage, and business loans.
On the other hand, bad loans are spent on consumer products or depreciating assets. Bad loans usually have no way of repaying themselves. They include Buy now, pay later loans, digital loans, emergency loans, credit card loans, and any expensive loans you can’t afford.
The biggest mistake you can make is taking multiple bad loans, thinking they will help you financially. This can often lead to loan stacking and loan addiction, which can cause loan dependency, negatively impacting your finances.
And that is not all. Here are five more reasons why loan reliance can hurt your finances:
One of the most significant drawbacks of relying on loans is increasing your debt-to-income (DTI) ratio which can hinder your financial progress. DTI is a percentage of your gross monthly income (before taxation) used to service debt.
Ideally, you should strive to keep your DTI below 36%. You will find yourself living paycheck to paycheck when you exceed this rate. You will struggle to save, invest, and, worse, finance your living expenses.
Ultimately, you’ll have less flexibility when budgeting or managing your money. And when you lose control of your finances, you will find yourself in a position where you have to take more loans. While this might seem like a short-term fix to your problems, it can have long-term consequences. For instance, the quality of your lifestyle will change, and you might find yourself in a debt trap.
Instead of taking out more loans that increase your DTI and put you in a tight financial position where you can’t manage your income, consider reducing your expenses to find money to pay off debt or save for important goals.
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Taking loans isn't bad. However, taking loans you can’t afford to repay without straining your finances is. You increase your debt burden and default risk when you keep borrowing money before paying off your existing loans.
Since loans are not free, additional debt also means additional interest and fees. You will not only be repaying your loan but also paying additional costs. If you didn’t utilise your loans in a manner that could cover these fees and repayment, you might experience reduced cash flow which can affect you in two significant ways.
First, you will struggle to meet other financial obligations, like paying bills. This will put you in a position where you must decide between necessary expenses like rent or food and debt repayment. Choosing the former will mean defaulting on your loans.
The second problem is when you have multiple loans but reduced cash flow, you will start thinking of prioritising payments. This can be almost impossible, as paying one loan might mean defaulting on another.
When loan dependency puts you at default risk, you will have to think of ways to save yourself. Some options to avoid default include consolidating your loans or liquidating your assets/investments to reduce the debt burden.
A debt cycle occurs when you constantly live beyond your means and spend more than you earn. And any time your expenses exceed your income, you will have to resort to borrowing to maintain your lifestyle.
While this can seem manageable initially, it can quickly get out of hand, and you will struggle to meet your obligations and find yourself in a financial crisis where you have to borrow to pay off old debt. When constant borrowing leads to such a scenario, it can be hard to repay the loans and even harder to break the cycle.
The best way to avoid the debt cycle is to be cautious of how you use loans and borrow responsibly. This can be achieved by living below your means and avoiding consumer loans that add no value to your overall finances. If you have to borrow, ensure you have a plan of using the funds to build wealth or generate income.
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Debt can be described as borrowing from your future income. When you take out a loan, you are borrowing money you must repay. If the loan you took can't repay itself, you will have to repay it using your future income.
This can put pressure on and limit your financial flexibility. Instead of using your future income to save or invest, you will dedicate them to paying back debts. This will reduce your ability to achieve any financial goals in the future.
Before you borrow, it's essential to consider the long-term effects of debt. Ask yourself if the debt you incur will affect your financial plans or your ability to make any plans. While debt can be helpful, the wrong types can lead to financial instability.
Taking out multiple loans simultaneously can hurt your creditworthiness. This can make it challenging to find lenders in the future or a job.
It can signal to potential lenders that you have a high level of debt and may struggle to repay new loans, forcing them to deny you a loan or offer your loans with high interest and bad terms. Additionally, if you have a history of frequently taking out bad consumer loans, some lenders might view you as a high-risk borrower even if you’ve repaid those loans.
A damaged credit history might also affect your ability to find a new job. Some employers usually ask for a CRB certificate to check your credit history for outstanding debts, salary garnishment, or if you have a history of loan dependency. Any bad report can indicate to the employer that you are financially irresponsible or unstable, which could hurt your chances of getting a job.
Before you take any loan, it is crucial to consider the long-term effect, even if you can afford to repay. For instance, having a history of taking low-value loans like Buy Now, Pay Later, or ambiguous personal loans can be misconstrued as bad credit-building tactics by some lenders. This can cause them to deny you a loan or offer you unfavourable terms like high interest and a short repayment period.
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Debt can be a vicious cycle that's difficult to break out of. It is easy to think that taking out more loans will solve your financial problems, but it can often worsen your situation.
Luckily, there are multiple steps you can take to change your habit and stop loan dependency. Here are some strategies that can help you regain control and start building your finances:
Start Living Below Your Means: This process involves living on a budget, tracking your spending, and making conscious decisions about your spending habits. By adopting this approach, you can avoid debt, improve your financial situation, and achieve your financial goals. While it requires discipline and a change in mindset, it can help you save, invest, and pay off your debts.
Avoid Impulse Purchasing: Unplanned and often unnecessary spending can quickly add up and lead to debt. Instead of taking loans to buy consumer products, consider adopting strategies such as using sinking funds to save for big purchases and waiting at least 24 hours before making a big purchase.
Increase Your Income: This can provide a more sustainable solution to financial troubles than relying on loans. With increased income, you can improve your lifestyle, increase your DTI, and qualify for good loans like mortgage and business loans. Income growth can also lead to long-term financial security.
Prioritise Debt Repayment: This process addresses your problem's root cause and provides a more lasting solution. When you prioritise debt repayment, you are taking steps to reduce the amount of debt you owe rather than adding to it. This can improve your creditworthiness, reduce financial stress, and increase financial flexibility.
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To effectively manage your debt, you must avoid taking multiple loans and only incur new debt when you have a clear plan for repaying it. Without a plan, you risk getting into more money troubles that might be hard to escape.
If you are facing a debt problem, don't hesitate to seek guidance from a financial advisor or credit counseling agency. They can provide the support you need to develop a budget and create a debt repayment plan, avoid potential financial pitfalls, and take control of your finances.