How to Manage Personal Loans

Think of loans like power tools. When used carefully, they can help you build something great. On the other hand, when used carelessly, they can cut your financial future to pieces.

There’s nothing wrong with taking a loan when you need it. In fact, it can bring an unparalleled amount of peace with it. However, if you’re not confident in your ability to manage a loan well, it may be better not to take one at all. It’s far better to live within your means than to take on debt you can’t handle. 

A loan should be a step on the path to your goals, so let’s look at how to manage loans efficiently.

Before taking out a personal loan, you should understand what you’re committing to and its financial implications. A personal loan is an unsecured loan type you can use for various purposes. Many borrowers prefer personal loans over short-term emergency loans or credit cards because they are often cheaper.

Regardless of your financial situation when taking out a personal loan, remember personal loans require fixed monthly payments. Missing the monthly payments negatively affects your credit score, making future loans more expensive or impossible to get.

So before you sign anything, make sure you can handle the payments.

A loan is a new fixed monthly expense. Before applying for your loan, understand your financial situation to know how much impact it will have on your monthly expenses. Make necessary arrangements and reductions in your expenses to accommodate your debt. 

You can minimise or eliminate discretionary expenses like dining out and unnecessary subscription services. Look out for discounts and cash-back offers to reduce your expenses. You can also shop in bulk to save a few pounds, which could go toward debt repayment.

You can also use the 50/30/20 budgeting plan, where 50% of your income goes to needs, 30% goes to wants, and then the remaining 20% to service your debt and savings.

There are budgeting apps, spreadsheets, and worksheets to help you with your planning. If you’re old school, you can use a pen and paper to help you track your expenses and plan your income as you service your loan.

As you reduce your debts, monitor your accounts and expenses and readjust your budget until you have no loans left. 

Managing Multiple Debts

With a good credit score and a low debt-to-income ratio, you can hold multiple personal loans concurrently from multiple lenders. However, managing multiple personal loans can be hectic, making it easy to default and negatively affect your credit score.

There are a few ways you can manage multiple personal loans:

Use a Debt Consolidation Loan

If you have multiple existing loans, consolidating them into a single personal loan with a lower interest rate can simplify your finances and potentially save you money.

Debt consolidation is the most common reason why people take out personal loans. 

Note, however, that a debt consolidation loan is also risky as taking out a new loan could adversely impact your credit score. In addition, do the math carefully. A lower monthly payment spread over more years can mean paying more in total.

Use the Debt Avalanche Method

When dealing with multiple lenders for multiple personal loans, you can manage the loans by prioritising the one with the highest interest rate. Implementing the debt avalanche method means paying the minimum monthly payment for each loan and then using any extra money to clear the one with the highest interest rate first.

Once done, you would focus your attention on the next loan with a higher interest rate than the remaining ones until you get to the one with the lowest interest rate. This method helps you save money you would have otherwise spent on interest and it can help you get out of debt quickly if you stick to the strategy.

However, check that you don’t feel discouraged about your progress in clearing your loans, since the debt avalanche strategy focuses on interest rates rather than loan balances. You may find that your largest loan has the lowest interest rate, but the method gives it last priority.

Use the Debt Snowball Method

Other loan management strategies focus on interest rates, but the debt snowball method disregards interest rates and instead prioritises loan payment. This method entails paying the minimum monthly repayments on multiple personal loans and then prioritising paying off the smallest loan.

The strategy is purely psychological–some argue that financial management has a psychological angle to it. It’s not just managing the numbers. Clearing the smallest loan first would create momentum, encouraging you to clear the remaining debt.

However, while the debt snowball method gives you a sense of progress, it doesn’t factor in the average interest rate on your loans. You could end up paying more in interest than if you had used another multiple loan management method like consolidating debt.

Setting up automatic payments helps you avoid paying extra payments due to late or missed payments. Many lenders offer an autopay discount for automatic payments, which can help you save a pound or two each month. Set up an automatic payment once your loan is approved. You will be notified when your first payment is due, which will help you know your monthly loan repayment schedule. Automatic payments help you make timely payments and ensure you pay the least possible amount each month. If you don’t want to set up a direct debit, set a reminder to help you make your monthly payments on time.

After making on-time payments on your loan for a while, there’s a likelihood that your credit score has improved. You may qualify for lower interest rates. Keep an open mind and consider refinancing your loan if interest rates have fallen since you took out your loan.

Shop around to see different lender offers. Refinancing would involve taking out another loan in place of the existing one, which can help you save on interest. Refinancing could still give you a better offer even when you have a short loan term, as is often the case with personal loans.

Make sure you have your calculations right so that you don’t end up spending more when the goal is to save on interest.

Your financial situation could have improved since you took out the personal loan. If you come into extra money courtesy of pay bonuses, a raise, or windfall, you may want to make a lump sum payment to offset your loan. Paying off your loan early means you would be debt-free, which is the best possible financial state.

Many lenders don’t have prepayment fees if you clear your loan amount before schedule. However, make sure your personal loan lender doesn’t have a prepayment penalty; otherwise, you lose out on the intended gains of clearing your loan earlier. Borrowers often feel the urge to clear their loans as they near the last payment schedules. Weigh the benefits and cons of doing so.

Personal loan lenders have different loan repayment terms. For example, some lenders charge you for full repayment before the end of your loan tenure. In such a case, making extra payments to clear your personal loan earlier might not make financial sense.

Your lender might also have options for borrowers struggling to make monthly loan payments. Read the terms of your loan contract to know if you have such provisions. You could qualify for hardship relief or a forbearance.

Some lenders have agreements that give you grace for a missed payment without affecting your credit score. Your lender could also allow bi-weekly payments instead of one monthly payment. Know what you’re entitled to and take advantage of the special allowances in your loan agreement.

Determine which bank account will hold the money you intend to use for your loan repayments. Using money from an account that accrues interest denies the chance to earn interest due to monthly withdrawals. Therefore, a savings account might not be the best account for the deductions.

An everyday checking account may be the most preferred account for repayments because it’s straightforward. You also don’t lose out on interest, as is the case with savings and brokerage accounts.

Debts can weigh heavily on you, which means you need to monitor your accounts and progress constantly. So:

• Check your accounts to ensure there’s enough money for the subsequent payments
• Ensure you’re not paying extra fees erroneously
• Track your remaining loan amount
• Readjust your repayment plan if needed

You should also monitor your credit score to ascertain proper reporting. Your credit score is vital to your financial status and affects the financial resources you’re entitled to.

So, in a nutshell, managing a personal loan well comes down to being honest with yourself about your financial situation, making a solid plan, and then sticking to it with discipline. It’s not always easy, but it’s simple. And the habits you build in the process will serve you well in many other areas of life.

Don’t let loan payments become a vague monthly drain you try not to think about. Know exactly where you stand at all times. And consider talking to a financial advisor like Believe Advisor Limited to help you manage your loans by creating a personalised plan to repay your debt. Contact us today for a free consultation.