Most of us associate loans or debt with a lack of proper financial planning. This is largely because people take loans for the wrong reasons.
Loans taken for the right reasons should end up benefiting an individual or institution. Here are six times when it makes sense to take a loan.
1. To improve your credit rating
Individuals and small business find it difficult to obtain large-scale financing due to a lack of credit history. So, to build a good credit profile, you can secure a small loan that you use to add value to your business and improve efficiency. However, this doesn’t give you the green light to take up a loan without a plan.
You should first identify the important tasks you can finance to enhance value ahead of your planned large-scale financing. You should also ensure you can afford regular repayments without hurting your bottom line.
Key take out: You can improve on your bottom line by acquiring a small loan, hence laying the ground to qualify for large-scale financing. The loan should generate value that will allow the repayment of the loan interest and principal at the time it’s required, or else your credit rating will drop and end up making things worse for you and your business.
2. To invest in your business
If you’re in need of extra cash aside from your salary, you can secure a loan to start a side hustle. This should be accompanied by a proper business plan detailing how the loan will add value to the business.
The business model should have reasonable assumptions and the financial projections should cater for the debt repayment.
You can also obtain a loan to purchase equipment and inventory for your business. The equipment purchased should help improve on the efficiency of the firm, hence creating value that allows the business to generate more income.
Remember, be keen when taking a loan to purchase inventory for your business. Take up long-term loans for inventory that have a low turnover, such as seasonal goods. Bargain for long-term loans with a long moratorium period to allow for sales, hence easing the payment of instalments.
Key take out: Loans secured for business investments should be accompanied by a viable business plan. Value should be created for every coin invested into the business so as to allow generation of revenue, hence allowing for the repayment of the interest and principal of the loan.
3. To achieve personal growth and ambitions
You can take up a loan to facilitate your education or even purchase a home. These are personal investments that will help you secure a higher income in future.
To finance such items, secure loans that you can repay comfortably using your current income. Do not plan for income that you haven’t received. Do not take up loans to fund activities that don’t add value or can be avoided. You may want to have your dream wedding or go to your dream country on holiday, but these are expenses that can be avoided as they do not add much value. They shouldn’t be funded through debt, but out of your savings.
Key take out: Secure loans for your personal growth to finance activities that add value to your life. Avoidable expenses should be paid in cash from your disposable income, not from debt.
4. To maintain liquidity
Most businesses face working capital challenges in their daily operations. A business may need to meet staff costs while funds are held up in inventory that has not yet been purchased by customers.
Financial institutions come in handy to offer short-term loans that help keep a business afloat and ensure continuous operation.
An individual may also face liquidity problems due to delayed salary payments. Taking up a short-term loan to cater for your immediate needs can be more cost effective than using your credit card, which may attract higher interest rates.
Key Take out: Take up loans to ensure continuous productivity and prevent loss of income in instances where your funds are not currently at your disposal.
5. To cover your emergencies
In some instances, an individual or business may encounter unexpected needs such as urgent medical attention. Your health is always a priority, since you cannot be productive if you are not physically fit.
Taking up a loan to meet these needs will ensure that corrective measures are taken at the right time, therefore, personal and business productivity is maintained.
Key take out: You can take up a loan to cover urgent needs that arise to avert a loss of income or revenue. However, you should be keen while taking up an emergency loan so that you secure the cheapest loan available, or possibly take up a relevant insurance cover to recover from unexpected financial challenges.
6. To consolidate debt
In some instances, we find ourselves having multiple debts. It is recommended that for ease of management of such credit that you obtain a loan that covers all the small debts, and pay them off. It’s easier to deal with only one loan instead of several. This can also help you to take advantage of better interest rates, which can help you to save in the long term.
Key take out: You can consolidate multiple debts by repaying them through securing a single loan at a lower interest rate. This can lead to huge savings in the long term.
Debt is not necessarily a bad thing if it helps you achieve a worthwhile goal. However, if you lose control, debt can be a trap. Go into debt only when necessary or for the purchase of an appreciating asset.
Ensure that the value add will enable you to repay the loan comfortably. Always consider your loan-to-income ratio – your current income or projected income should always be able to cover the repayment of the loan principle and interest. Be smart enough to shop for the best interest rate.
The writer is a private equity market research analyst at Cytonn Investment.