Getting approved for a loan and being able to comfortably afford one are two different things. A lender might decide that your income and financial position meet its requirements, but that doesn’t necessarily mean the repayments will fit neatly into your life.
Before borrowing, it helps to look beyond the amount you’re eligible for and consider what the loan will actually mean for your monthly finances. Taking time to compare personal loan options can help you understand differences in repayments, interest rates, fees and loan terms before deciding whether borrowing makes sense for you.
The key question isn’t simply, “Can I make the repayments?” It’s whether you can make them comfortably while paying your other bills, dealing with unexpected expenses and still having enough money left to enjoy your life. Here are five practical ways to work that out.
1. Calculate What You Really Spend Each Month
Start with your actual spending rather than what you think you spend.
It’s easy to remember major expenses such as rent, utilities and groceries while forgetting the dozens of smaller purchases that gradually eat into your income. Takeaway meals, streaming subscriptions, petrol, online shopping and weekend activities can add up to a significant amount.
Look through a few months of bank and credit card statements and divide your spending into categories such as:
Once you subtract these expenses from your take-home income, you’ll have a much clearer picture of what is genuinely available for another repayment.
2. Test the Repayment Before You Borrow
A useful affordability test is to pretend you already have the loan.
Suppose the estimated repayment is $400 a month. For the next two or three months, transfer $400 into a separate savings account as soon as you get paid. Then leave it there.
If you can manage comfortably without that money, that’s encouraging. Better still, you’ll have built some additional savings in the process.
If you repeatedly need to transfer the money back to cover groceries, bills or other normal expenses, pay attention to that warning. The repayment might technically fit into your budget on paper while being uncomfortable in real life.
This simple exercise can reveal far more about affordability than looking at a calculator alone.
3. Allow for the Expenses That Don’t Arrive Monthly
One of the easiest budgeting mistakes is calculating affordability based only on regular monthly bills.
Real life isn’t that predictable.
A car might need repairs. Your annual insurance premium becomes due. A pet needs to visit the vet. You might have a wedding to attend, need to replace an appliance or receive an unexpectedly large utility bill.
Go through the previous year and identify expenses that occurred occasionally rather than monthly. Work out roughly what they cost over 12 months and divide the total by 12.
For example, if irregular expenses totalled $3,600 over the year, that’s effectively another $300 a month your budget needs to accommodate.
Accounting for these costs can turn an optimistic budget into a much more realistic one.
4. Consider What Happens If Your Circumstances Change
It’s tempting to calculate affordability based on everything going according to plan. A better test is to ask what happens when something doesn’t.
You don’t need to prepare for every imaginable disaster, but you should consider realistic changes that could affect your finances.
What would happen if your working hours were temporarily reduced? Could you handle the repayment if rent increased? What if your car required an expensive repair in the same month as another major bill?
Savings can provide an important buffer here. If taking out the loan would leave you with almost nothing available for emergencies, the repayment may be putting too much pressure on your finances.
You may decide to borrow a smaller amount, wait until you’ve built a larger savings buffer or reconsider whether borrowing is necessary.
5. Look at the Total Cost, Not Just the Monthly Figure
A manageable monthly repayment can make a loan seem affordable, but it doesn’t tell you how much borrowing will ultimately cost.
A longer loan term, for example, may reduce individual repayments while potentially increasing the total interest paid over the life of the loan. Fees can also add to the overall expense.
Before making a decision, look at the complete picture. Consider the amount borrowed, repayment frequency, interest rate, applicable fees, loan term and total amount repayable.
Then ask yourself whether what you’re buying is worth that total cost.
This is particularly useful when the loan is funding something optional. A purchase that seems reasonable when described as a monthly payment may feel very different once you see what you’ll pay altogether.
Give Yourself Some Breathing Room
The best budget isn’t one that works perfectly down to the last dollar. It’s one that leaves room for normal life.
Before committing to a new loan, work out your real expenses, test the repayment, account for irregular costs and consider how you’d cope if circumstances changed. Most importantly, leave yourself some financial breathing room.
Being able to make a repayment is important. Being able to make it without worrying about every unexpected bill that arrives is a much better measure of whether a new loan truly fits your budget.
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