Financial discipline and planning are the basis of monetary well-being. Consumers must comprehend the fundamentals of borrowing to survive challenging economic times. One basic fundamental rule of borrowing is to match funding to expenditure.
The development of financial markets providing different forms of credit has stimulated economic growth. Unless individuals understand exactly what is available and when it is appropriate to access different lending streams, the advantages of savvy use of the available lending formats risks becoming a personal economic burden. This usually happens when there is a mismatch between the form of credit raised and the uses that it is then put to.
Long term loans should only be used to finance long term assets. A house is purchased with the long term view to inhabit it, and should be financed with a mortgage, typically over 25 years. Without the availability of a mortgage few people would ever own their own home. They would have to save up a large capital sum as well as pay rent while doing so. Similarly most consumers will not have the free savings to go out and buy a car for cash. Without the availability of say three year hire purchase finance, it might take them several years to save up the purchase price whilst paying for others forms of transport in the meantime.
Short term loans should only be used to finance short term expenditure. Traditional bank overdraft; credit card borrowings; and the newer unsecured on-line loan products coming on the market fall into this category. They should only be used to pay for expenditures accommodated within personal budgets where there is a temporary funding short-fall. Holidays; unexpected medical expenses; seasonal expenditure at Christmas; and a large car repair bill all fall into this category.
Raising a second mortgage to finance any of these types of expenditure breaks the rule. Conversely would using one of these short term loan streams to pay part of a finance deposit or make a monthly repayment on a car or house purchase.
The pitfalls of mismatching funding are:
- You risk inadvertently living beyond your means which is unsustainable
- You will pay higher fees and interest rates than you otherwise would
- Savings can become unnecessarily depleted
- You risk breaching lenders terms and conditions, which can cause you problems later on
- You risk forfeiting a long term assets (house of car) and you risk damaging your financial reputation, which can restrict your future funding options.
A recent customer survey by the reputable instant online loan provider Wonga recently concluded that a greater awareness and understanding of how money works is much needed to get South African consumers on the road to financial well-being. An appreciation of the borrowing matching principal and its application in the real world will help you stay financially fit, and demonstrate that you have the financial literacy required of the modern consumer.
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