Borrowing for a high-risk investment such as cryptocurrency should align with your risk tolerance and ability to repay debt if the market crashes.
Katrina Shanks is the Managing Director of Financial Advice New Zealand.
OPINION: Most of us have had personal loans – whether it’s car loans, mortgages or home improvement loans, to name a few, in our lifetime.
These loans have most likely been a mix of nice and much-needed purchases.
There are three kinds of debt: good, good and bad. Let’s take a look at each of them.
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Investment debt is good because it aims to help you build your wealth for a secure future.
However, investment debt should be considered carefully. For example, borrowing for a high-risk investment such as cryptocurrency should align with your risk tolerance and your ability to repay debt if the market crashes, as we’ve seen over the past few months. .
Mortgages are acceptable debts because they serve a purpose and are usually for something that is likely to give you a return over time.
Personal loans are generally bad debts, although there are exceptions.
These exceptions include when you are borrowing to do something like consolidate your loans or credit card debt into one loan, which is often at a lower interest rate. Or even to buy a vehicle to help you get to your place of work, which provides you with a source of income.
Until Covid-19 arrived, personal loans were relatively easy to obtain. Simply prove your ability to repay the loan by showing your payslip, and you’re away.
But that has now changed, as rising interest rates and lower risk tolerance from major lenders have combined with a general lack of basic financial knowledge and good financial behaviors on the part of many people to make them more problematic.
One of the most common debts is the mortgage. About 1.1 million people have it, with a total value of $34 billion.
The most dangerous debt is what is commonly called payday loans.
This is a very expensive short-term loan that you must repay within a specified time. If you don’t, the high interest rate builds up significantly to the point that you could end up paying four or five times the original amount.
I’ve seen one with an interest rate of 0.8% per day, and when you add administration fees, that can make borrowing very expensive. At this rate, it is the highest cost of borrowing you can have.
For example, the full repayment for two weeks for $500 can quickly turn into $541, or $1091 for a $1000 loan. Often, on top of that, there will also be a setup fee of up to $300. And there are more costs if you fail to repay your loan. If you do, it can add $30 per week to the total.
Because you are borrowing money that you cannot afford to spend, you are immediately at a disadvantage.
If you can pay it off in a few weeks, that’s fine, but sometimes getting on the treadmill is easier than getting off, and once you’re there, it’s tempting to stay there and go. have more.
A few golden rules:
- Ideally, only borrow if you know you can repay it on time.
- Have a financial plan, so you know the big items in the future, whether it’s replacing a washing machine or a new car.
- Try saving for what you need and want instead of borrowing.
- Have an emergency fund in case the unexpected happens, so you don’t have to borrow money and go into debt.
- Be aware that your loan application may show up on your credit report, which means other lenders will see that you need funds.
- Only take out a payday loan if you have no other options – use it as a last resort. There are alternatives, and you should consider them before applying. These include Work and Income (if you are on stipend), The Good Shepherd and Salvation Army (as long as you are on a limited income) and BNZ (special rates for students, apprentices and recent graduates ).
I’ve had personal loans throughout my life – I had a mortgage and a credit facility for a larger purchase when I was younger and on a budget, but I needed to buy some things like a bed, a lawn mower and a TV.
My rule was to borrow only for necessities and to save for the better off.
As my financial advisor would say, a personal loan should be a last resort, and saving for something is better than borrowing.
There is no risk if you have to wait a few weeks or a few months to raise the money you need.