Having debt can have a lot of effects on your life – your credit rating, how you save, how you budget. But even if you have debt that you are working to pay down or pay off completely, you still may be faced with a situation where you need to borrow money for something else. So, how does someone take on a new loan without being irresponsible about it?
Good Debt vs. Bad Debt
Not all debt is created equal, and while too much of any kind of debt can be financially precarious, there is nuance between so-called “good” debt and “bad” debt. And that label – good vs. bad – often has a lot to do with what you’re using the money you’re borrowing for. Taking out a loan for a responsibly priced vehicle that you use to commute to your job or school, etc., is very different than taking out a loan for a high-priced luxury vehicle with all the bells and whistles just because you want to cruise in style. The first one can potentially positively contribute to your future financial position; the second one likely won’t. Good debt includes things like mortgages, student loans, home equity loans, home equity lines of credit, and small business loans.
Responsible vs. Irresponsible Borrowing
Similar to good vs. bad debt is the idea of responsible borrowing vs. irresponsible borrowing. The idea is to take on debt only when necessary for money you need, not luxuries or excesses that you don’t truly need, don’t contribute beneficially to your financial future, and will likely lead to stress and strain. Responsible borrowing also includes taking out loans with a clear plan on how to repay them and a thorough understanding of their terms and interest rates.
7 Steps for Borrowing Responsibly with Debt
1: Take an Honest Look at Your Finances
No plan or decision is going to go well if you’re not clear and honest about your starting point. Take a step back, maybe use a budgeting app or something similar, and make sure you know: your income, your expenses, and your current debts and responsibilities. All of this information is necessary for you to get a big-picture view of where you can and need to build in order to ensure a stronger financial future.
2: Get Familiar with Your Credit Score and Credit Report
Having debt can impact your credit rating, which then affects future loans and rates, but it does you zero good to stick your head in the sand and choose blissful ignorance when it comes to your credit score. Knowing where you’re at can help inform small steps you can take toward bettering your rating.
According to USA.gov and the Consumer Financial Protection Bureau, you can get your credit score by checking your credit or loan statements, talking to a credit or housing counselor, finding a credit score service, or getting your score from one of the three major credit reporting agencies (Equifax, Experian, and TransUnion). Agencies like Experian, recommend checking your credit report at least once a year, but also in the case of situations like: when you’re planning to apply for credit for a major purchase, when you’ve received notice of a data breach, when your financial and personal information has been stolen, or when you’ve accomplished a major credit milestone like paying off a student loan.
3: Make Sure You’re Borrowing for the Right Reasons
You’re aiming for good, responsible borrowing that helps you stay grounded. You don’t want to be taking on another loan for an island vacation or impulse buys at CostCo or on Amazon. And never borrow more than you need.
4: Research Your Options Thoroughly
Borrowing money when you already have debt requires going through your options with a fine-toothed comb. Look into the types of loans that might meet your needs, what interest rates might be available to you, and what kinds of fees you might incur. Also research any financial institutions that have loan offers and make sure that they are recognized lenders who are licensed in the states they operate.
5: Understand the Terms and Conditions
It might go without saying, but don’t sign onto any loan where you haven’t fully read and understand the terms and conditions. That fine print can be overwhelming, but it’s essential to be thorough when you’re looking it over. You don’t want to miss text that will leave you with unexpected fees, penalties, or impossible repayment conditions. The lender should be ready and willing to answer any questions or concerns you have. If you aren’t suer about all of these terms, check out our blog, “Loan Lingo,” to study up. [insert link when posted]
6: Create a Repayment Plan
Borrowing with no idea how you’re going to repay the money you’re taking out, with just vague ideas that future you will handle it with future money, is a setup for financial stress. Before you sign the paperwork, make sure you know when your loan payments will be due and how much will need to be paid each month to stay on track. If you don’t have a clear idea of this, you might end up taking on a loan burden you can’t conceivably handle.
7: Monitor Your Debt-to-Income Ratio
Calculate how much you currently pay each month toward debts. Divide those payments by your monthly income. That is your debt-to-income ratio, and it's a good way of identifying what level of debt you can take on. Most financial professionals say to aim for a debt-to-income ratio of under 36%, so if you’re current DTI is around 20%, you have wiggle room to take on additional debt obligations.
Be Responsible. Borrow Smart.
Having debt is not inherently bad or irresponsible, and it doesn’t make it impossible for you to borrow additional money when you need it. It’s about the process you use and the steps you take to ensure you’re being smart about the loans you take out and the lenders you work with. Lending partners like WithU Loans can help you with support, stability, and responsibility that make it possible to manage your financial situation.
