When Is Taking out a Loan a Good Idea? – Wells Fargo

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When Is Borrowing the Right Move?

Invitations to open new credit accounts are everywhere you look ― in the mail, on TV, in stores, and online. As tempting as they may be, it’s important to carefully evaluate your financial situation to determine if taking on more debt is a wise choice. Start by answering these key questions:

Is it “good” or “bad” debt?

Before you borrow, determine if the debt you’ll be taking on could have a positive or negative impact on your finances.

  • “Good” debt may help you reach your life goals. A student loan or mortgage is an example of debt that may have a positive impact on your future. This type of borrowing can be seen as an investment in your future. Make sure the payments and fees are manageable for you in both the short-term and long-term before you take on any new debt.
  • “Bad” debt provides no long-term return. Taking out a loan to finance a vacation or using credit cards for shopping sprees, recreation, and dining out will only put you deeper in debt and increase your monthly payments.

 Limit Your Debt 

Use cash and credit to fund large purchases or projects. For example, use cash to pay for project materials, and a line of credit to pay for labor.

What are my options?

Before you borrow, ask yourself:

  • Will borrowing improve my situation in the long run or is this an impulse purchase? 
  • Could I wait until I can pay for this without having to borrow?
  • Is there an alternative to borrowing ― like selling something I own to fund the purchase?
  • Could I use my savings to pay for it instead of borrowing? 
  • Will the additional monthly payment strain my budget and cash flow?

 Avoid impulse purchases 

If what you want is over your pre-set budget, take a couple days to think about it. You may just find you’re no longer interested in taking on more debt.

When borrowing may make sense:

  • Reducing your interest rate on your existing debt. An example would be consolidating existing high-interest credit card debt with a new personal loan. You will want to ensure you understand the total cost of borrowing with your new loan and be cautious not to charge back up your credit cards once they are paid off with your new consolidation loan.
  • Preserving your cash reserves and financing specials. There may be times that you have saved for an item, but may get a better price or tax benefits if you borrow. Some car dealers have price specials if you finance the purchase. It may make sense to take advantage of this kind of offer and then pay the loan off in the near future. Just ensure there are no prepayment penalties if you want to pay off the loan early.
  • Maintaining your long-term investments. Even if you have the money in your 401(K), it generally a bad idea to dip into your retirement savings early. It can derail your savings effort for retirement and there may be potential penalties and fees that have negative impacts on your long-term financial plan.