A Guide to Affordability

Things can go badly if you take out a loan and fail to meet the monthly repayments. Whether or not you take a loan out depends on how confident you feel about your finances. Ultimately, can you afford it?

Women happy to borrow from her friends.

A loan can help make a big purchase more affordable or help you get out of a tricky spot by spreading the cost over a longer time frame. If you pay back your loan repayments on time, it can even help you improve your credit score.

But if you take out a loan and fail to meet the monthly repayments. Things can turn bad. You'll risk damaging your credit score and falling into deeper debt. So, whether or not taking out a loan is worth it depends on how confident you feel about your finances.

Ultimately, can you afford it?

What we cover in this guide 🤘

Debt in numbers

People in the UK owed £1,810.7 billion at the end of July 2022. The average total debt per household, including mortgages, was £65,151. Per adult, this was £34,235, around 107.5% of average earnings. 

Based on July 2022 numbers, the UK's total interest payments on personal debt over 12 months would have been £48,199 million, an average of £132 million per day.The average annual interest per household would have been £1,734 and per person £911, which is around 2.86% of average earnings.

It is fair to say that debt is big business. It costs so many of us thousands of pounds each year. Switching to more affordable ways of borrowing, such as friends and family loans could help reduce your overall outgoings, and so help you come better with the rising cost of living in the coming months.

Is it better to borrow now or to save up towards something?

This is something that only you can decide. It is certainly better to avoid unnecessary debt if possible. If you can hold off until you can afford it saving up is the way to go. 

But there may be instances where borrowing money could save you money over time, such as buying a washing machine will save money compared to going to a laundrette or buying a cooker will save on the cost of takeaway food. Borrowing money to pay for a course, a computer for work or a vehicle to travel to a job may allow you to earn more money and therefore could be a good investment in the long run. 

Even expensive things such as buying a home could save you money over renting and increase in value while you own it. Often saving up a deposit for a home can take many years (even decades) and so a loan from someone you know could be a helpful way to get onto the housing ladder, provided you can afford to repay them. 

Borrowing money for fast fashion or fancy cars may seem attractive at the time but you should ask yourself whether it will be worth it in the long run if you can’t afford to pay back the loan.

The danger of too much debt

Not only can debt be expensive (you can find some info on borrowing rates here) but it’s also hard to keep track of. Buying lots of things using Buy now Pay later products can soon add up to more than you thought. Credit card purchases can add up over time until the total becomes too big to tackle and the easy answer is to roll it into another credit card or consolidate it into another kind of bank loan. 

In 2022, Credit card debt averaged £2,230 per household and £1,172 per adult in the UK. Repaying this with the average interest charged on credit cards would take 25 years and 7 months to repay (making only the legal minimum repayments each month).

The minimum repayment in the first month would be £59 but would reduce each month. if £59 were paid every month, the debt would be cleared in around 5 years and 1 month.

If this money was borrowed from a friend or a family member on a 0% loan and repaid at £59 a month, it would only take 1 year and 8 months.

Checklist before deciding to get a loan

Both the lender and the borrower need to have considered the full implications of creating a loan with a friend or family member before they agree on the terms. If you don’t think it’s needed or you don’t think it’s affordable, maybe you should consider whether it’s the right thing to do.

Ask the following questions before making that decision.

1. What's the loan for?

Have a clear reason for why you’re going to borrow money. Understand exactly what it’s for so you know how much you’ll need to borrow. 

2. Do I need it?

Once you know what it’s for, work out whether you need it. Depending on the reason for the loan, do you need it right now, or can you save up towards it and buy it later down the line?

3. How much will it cost?

When borrowing money, interest is usually applied. Lenders will calculate interest as a percentage of the amount you owe. You need to work out exactly how much this will cost on top of the money you are planning to borrow. 

Always take into account the APR of loans or credit products, this figure takes into account the total amount applied like fees or one-off costs.

4. Am I confident in managing the repayments for the entire loan period?

45% of adults in the UK aren’t confident in managing their money day to day. You’ll likely be repaying your loan for a least a few months, but it could also be for years down the line. You need to be able to manage the repayments over a long period and control other areas of your spending.

Punk Money Tip - Loans can add up quickly

Even affordable loans can add up faster than you think. If you're borrowing friends or family you should be sure that you can afford it. And that the person you're borrowing from isn't overburdening themselves with too many loans or in danger of slipping behind on their repayments.

How to work out if you can afford a loan?

Once you have an idea of how much you need to borrow or lend to someone else. You can start to understand what it’ll cost you and it’s time to see if you can afford the loan.

A good place to start is your monthly income and outgoings - or your budget. You’ll work out how much you earn and how much you’ll spend and what you’ll have left at the end of the month, then see if it’ll cover the repayments of your loan, or be without the cash you’re lending. If not, you risk racking up debt, which can be stressful and expensive for both the lender and the borrower.

It’s also sensible to think about how you’ll cope if your situation changes. What if you lose your job? Or if the price of your bills increases? Can you still afford to make the repayments on the loan, or be without the cash that you have lent to your friend or family member.

When you borrow money, it’s important to avoid late payments as they can lead to extra charges and a damaged credit score.

Make sure it’s affordable - making a budget that works for you 

A budget is a spending plan based on your income and expenses. Or how much you make versus how much you spend. The goal of budgeting is to learn how to control your money. It’s a little bit of work to create one but it shouldn’t be treated as a punishment. But, a way to create a healthier relationship with you and your money. 

Your budget should work for you and the goals you have. It can change over time after you’ve saved a certain amount or paid off your debts. Budgeting smartly should cut down your costs, give you more confidence over your money and leave more room for the fun stuff in life.

If you’re looking for a simple way to track and manage your income and outgoings, you may find our free budget template a good place to start. Click here to get it🤘

Why is budgeting important?  

Understand where you spend your money: 45% of adults in the UK don’t feel confident managing their money. And more have no idea what they actually spend their money on.

A simple budget can give you a clear picture of your finances. Helping you understand what you spend your cash on, so you can start to spot trends where you can make savings. Like all those subscriptions that you forgot about. 

Save for the future: Whether it’s a holiday or a house deposit, we all have goals in the future that require us to save. If you work out how much you need to reach these milestones, you can start to put money away each month. A budget is essentially a plan for how you will reach these goals.

 Manage or stay out of debt: When you owe money on your credit cards or loans, it can be tricky to understand the impact of the interest on upcoming payments. Working out exactly how much these will be, against your income will give you a clear idea of your next steps. So you can spot problems before they spiral out of control.

Punk Money Tip - Try not to make estimates

Budgets shouldn't be guessed or estimated. They should be planned. Take some time to look through all of your accounts to find out exactly what you're spending your money on (and how much). Your budget won't be successful if you're not using accurate figures.

How to make your budget?  

How much money do you have coming in?

Add together all your monthly incomings (income, wages, pensions etc.) or if the budget involves other people too, add those in too. 

If some of your income is paid weekly or 4-weekly, you’ll need to turn these figures into calendar monthly amounts to get an accurate figure. Just multiple the weekly figure by 52 and then divide this by 12. 

How much are you spending?

Go through your accounts and receipts and make a list of everything you spend your money on each month.

Work out what you spend your money on each month by making a list of all your monthly expenses (bills, subscriptions, rent etc.) and also the items you only pay for once a year or less. 

To do this - divide the yearly cost by 12 to give you the monthly figure. 

How much do you have left over?

Take the total amount you’re spending money on each month from your monthly incomings. This will tell you if you have money left over each month (a budget surplus) or if you're spending more money than you have coming in (a budget deficit). 

Free Budget Template 🙌

If you’re looking for a simple way to track and manage your income and outgoings, you may find our free budget template a good place to start. Click below to download the PDF.

Getting your answer on loan affordability 

Once you’ve worked out your budget accurately you can start to understand how much spare cash you will have left at the end of each month. This should paint a picture of your finances and tell you whether it is wise for you to take out a loan or lend your cash to someone else. At the least, it should act as a guide for how much you can afford to take out.

What next?

If you are confident that the loan is affordable you can talk to a friend or family member about setting up the loan. You could even share your budget with the other person to give them full confidence in your ability to repay the loan. After all, a bank would ask you to do this. So why not do the same with the person you’re borrowing from?

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