The greatest risk of taking out a short-term loan is the high cost if you miss a single payment. Just one late payment can rack up huge penalties and extra costs, and you can easily end up owing far more than you bargained for. You may think you’ll have no difficulty paying back your loan, but it can all too easily go wrong.
If you’ve ever found yourself saying, “I’ll be fine as long as nothing else happens,” that’s one of the biggest danger signs. If you’ve budgeted down to the last Euro for rent, bills, food, and your loan repayment, then it doesn’t take much of an emergency to make a big dent in your carefully planned finances.
For example, what if:
- the car breaks down and needs repair?
- the kids ruin their school clothes and need new ones?
- the dog has to go to the vet?
- the electric bill is higher than you expected?
- you lose your phone?
If you’re only taking out a short-term loan for a few weeks, then there’s only a small risk that something like this will actually happen. But if your loan is going to take several months to pay off, it’s more than likely that another crisis will happen at some point. Then you’ll be faced with a horrible choice: which payment are you going to skip to deal with the new emergency?
You don’t want to skip the rent and risk being homeless. You don’t want to skip the bills and have your power or internet cut off, followed by huge reconnection fees. And you don’t want to go without food. So that leaves your loan payments – and you really can’t afford to do that.
When you’re planning how you’re going to repay your loan, allow a little for unexpected emergencies. The longer your loan period, the more you should allow out of each pay check. Put that money aside somewhere, and don’t be tempted to spend it until you’ve paid back the whole of your loan – or if you ever save up enough to pay off your loan early, consider doing that.
It may make more sense to take a slightly longer loan and be more certain of paying it back, even though it may cost more. For example, say you’re borrowing €400 and trying to repay it in two months, you may have to pay €275 a month, and it’ll cost you around €150 in interest. Maybe you can just about manage that if nothing else goes wrong. But if you have an unexpected emergency and miss just one payment, it could easily end up cost you hundreds more.
But if you give yourself three months, you’re now only repaying more like €200 a month. It’ll cost you an extra €50 in interest at the end of it, but it’s a lot less risky because your loan payments are €75 lower. Now, if the kids need new shoes, you can afford them and still make that loan payment. And if nothing else goes wrong, after two months you’ll already have €150 saved up, which is almost enough to cover that final payment.