Perils of Taking Debt
December 11, 2020

People when they start earning like to live on monthly instalments in the UK as they rely on loans to fund most of their purchases. A significant portion of their monthly salary goes into serving interest on the loans they have taken to buy the latest smartphone or their favourite car.

Credit card is one of the most significant sources of incurring debt for millennials in the UK, it is a useful instrument, but it has specific issues as well. As long as you are paying promptly, it is all hunky-dory, however, if you miss any repayment by even a day, the interest on that is exorbitantly high.      

There are direct lenders available online who are offering urgent loans in Ireland to even bad credit borrowers. These are unsecured loans for which you will not have to pledge any asset as collateral and nor you will have to produce any guarantor to represent you.

There is an instant decision on these loans, and thus you get the loan amount in your bank account on the same day you applied for the loan, once it is approved. But, it comes with its share of problems for borrowers which are very high-interest rates.

This blog will explain the disadvantages and opportunity cost of taking a loan. Here it goes:

  • Interest Burden

The basic premise behind loans is that the lender charges interest on the amount lent. Therefore, you end up paying a significantly higher amount than what you borrowed initially.

The interest rate determines the difference in the loan amount and the total amount of repaid. This interest rate is even higher if your credit score is bad and thus you might have to pay the double of what you borrowed if the loan’s tenor is longer. Direct lenders quickly approve loan applications of even bad credit borrowers. However, they charge interest rates to the tune of 60-80% per annum based on your profile.

Thus, the interest burden is one of the most significant demerits of applying for a loan, from the borrower’s perspective.

  • Opportunity Cost

Suppose you have taken a loan and you are paying regular monthly instalments for it. Now, were you not a borrower, you could have invested this money somewhere and earn interest on it. This is the opportunity cost of taking a loan that you miss out on earning more money via investments.

As a fiscally prudent person, you should earn interest on your investments rather than paying interest on your borrowings. Now, since you have taken a loan, your savings are going into monthly instalments and you are missing out on creating your wealth.

  • Credit Score Deterioration

The credit score is one of the key deciding factors for lenders to give approval or rejection decision on a loan application. If you have a substandard credit profile, then there are high chances that established commercial banks will reject your loan application.

This will further exacerbate your credit score, making it difficult for you even to get urgent loans offered by direct lenders. Besides, if you miss payments by a few weeks during repayment then also your credit score gets affected. This will debilitate your chances of getting loans in emergencies.

  • Penalty for Late Payment

You now know that if you miss any repayment deadline, then your credit score is affected. On top of that, you will have to pay penalty charges also if you are a defaulter. This penalty amount is for the delay in meeting repayment obligations.

This penalty amount differs from lender to lender, some charge it as a onetime fixed amount and some charge it on a pre-determined percentage basis. It means you have to repay the principal amount, you have to repay interest component on that principal amount and you would have to pay late fees and all this because you desperately wanted the newest Smartphone.  

  • Fore Closure Charges

Many lenders in the UK and even around the world insert the foreclosure charge in case of early repayment of the entire loan.

Suppose, if you got a significant amount from a business deal and you want to settle the entire loan with one payment before the tenor ends, then you will be asked by the bank to pay a charge for closing the loan account early.

You will benefit in this scenario from the excess interest that will not be charged now but to compensate that you will have to pay foreclosure charges. Moreover, you are back to square one.  

  • Assets are Seized

Loans are of two types: Secured Loans and Unsecured Loans, the former is backed by an asset, and the latter is not. A borrower has to pledge any of his asset with the lender as a security against the loan. This asset could be the papers of his house, his factory, equity shares he holds, his car, the jewellery they own etc.

Until you repay the entire loan amount, your assets would be in the custody of the lender, and you will not be able to sell them. This is another setback of borrowing money from a financial institution.

The bottom line is that don’t go for loans unless it is badly needed, borrow only if there is some emergency else avoid it. Buy things you can afford and pay from your savings, don’t buy things you cannot afford and for which you have to incur debt.

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