People borrow money from the bank for a variety of reasons. Homes, cars, major appliances, renovations, education and business start-ups are some of the common reasons. Before taking out a bank loan, you need to weigh the pros and cons of doing so relative to other financing options.
Meet Short-term Financial Needs
By borrowing from a bank, you have a way to fund near-term financial purchases or to achieve short-term goals. If college fits well in your life plans but you don't have the savings, a bank loan can help you get started. Similarly, small business start-ups are often funded either by bank loans or equity investment. With a bank loan, you get the needed funds with no obligation to share future earnings with investors.
Low Rate Potential
Depending on the nature of the loan, you can often find low-interest-rate financing, which makes bank borrowing a wiser choice than racking up the balance on a high-rate credit card, for example. Home and auto loans, for instance, typically have low rates because you secure the loans with the property you purchase. Fixed-rate home loans below 4.5 percent are relatively common for home buyers as of early 2019. You may even get a personal loan below 10 percent without offering up collateral if you have excellent credit.
Cash Flow Restrictions
The tradeoff for getting the funds you want or need now is the need to allocate future income to pay off the debt. If you have a monthly loan payment of $200 over a 10-year payment period, you effectively eliminate $200 of cash flow during that repayment period.
Borrowing from the bank presents two significant personal and financial risks. One is the risk of property repossession if you don't pay back a loan secured by your home or car. Losing your home to the bank is a major financial burden. Even if you don't secure a loan, you risk damaging your credit rating by making late payments or defaulting on personal loans. This impedes your future borrowing potential and the chances of getting favorable rates.
Neil Kokemuller has been an active business, finance and education writer and content media website developer since 2007. He has been a college marketing professor since 2004. Kokemuller has additional professional experience in marketing, retail and small business. He holds a Master of Business Administration from Iowa State University.