The Ultimate Personal Loan Guide Part 3: Chapter Two - Loan Affordability

Loan affordability is crucial to think about before taking out a personal loan. Personal Loans Now examines what you need to think about prior to committing yourself to a loan. We also provide you with ways to assess your affordability of repayment.

Loan Affordability - Personal Loans Now

Learning Highlights
  • Loan Affordability
  • Affordable personal loans
  • Debt to income ratio
  • Assessing the ability to pay
  • Easily available personal loans

Loan Affordability: Should a Loan Be a First Or Last Resort

One of the most important aspects to consider before applying for a personal loan is to ask the question ‘Is borrowing the right option for me?’

“Loans should be an absolute last resort and only be used in an emergency, not to splash out on holidays, luxury items or new cars. To see that so many use loans to make ends meet or repay existing debt is very sad. There is help available to those with financial woes, so people should seek out their other options before turning to loans.” – The Money Pages December 2014

An unsecured personal loan can often be the right choice to pay for a large expense especially when you have little or no savings. It is a state in which many families find themselves in these straightened economic times.

However, there are other choices for short term borrowing that offer more flexibility. For example, you could use a credit card or an overdraft.

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If the financial hole that you are in is only going to affect your life for a very short term, then it might be wise to think about one of the other options. Personal loan agreements can tie you to monthly repayments for many years.

Lenders allow a wide choice of loan periods. You might see a personal loan advertised for as short a time as six months. But, in reality, most lenders will prefer a minimum term of one year. Maximum terms often stretch to 7 years or even ten years. The fact is that the longer the loan lasts, the more money you will end up paying out in interest and other fees.

Also, lenders are entitled to add some extra interest if you ask to repay the loan at an earlier date than agreed. Fortunately, the extra amount that they can charge is limited.

So you imagine you have looked at other options. You have decided that you want to go forward and take out a loan. The next question to ask is ‘Can I afford to make the repayments?’

Loan Affordability - Personal Loans Now

Affordable Loans

The attraction of getting your hands on a lump sum may blind you to the realities of taking out a personal loan. Before committing to the application, draw up a budget showing all your monthly income and outgoings. This is an excellent idea to see whether you can afford it.

It is quite possible that you have some money to spare each month and that could finance the loan. But you may just find that the repayments will stretch your existing budget to the limit.

If this is the case, it may be time to consider getting some free, impartial advice from one of the many debt charities before you commit to paying out, even more, money every month.

Reporting suggests that it is only payday loans that can push people into debt. But this is not the case. The FCA extensively changed the payday loans business by putting a cap on charges. However the price cap does not cover two avenues of borrowing; door step lending and the latest scourge of the consumer, ‘rent to own’.

Loan Affordability - Personal Loans Now

Applicants with a poor credit record may apply for a personal loan but lenders will charge them a much higher rate of interest. This is something to take into account before borrowing.

Personal Loans With Instant Approval

Looking through advertisements from many lenders will often cause you to come across offers for ‘instant approval personal loans’, ‘personal loans with no credit check’ or low ‘personal loan interest rates‘.

Users of high-cost credit are also far more likely to be in insecure situations – and are more than twice as likely to have dependent children or have a disability than the general population. There is a moral case to protect those consumers who have little choice but to borrow from high-cost lenders – The Guardian January 2017.

Therefore, it is vital to be totally up front with yourself. Work out whether, given your current financial circumstances, a personal loan is truly affordable. One of the main problems that can occur with personal loans is whether or not you have the financial capacity to afford one.

Loan Affordability - Personal Loans Now

How Do Lenders Assess Loan Affordability?

Lenders use a variety of criteria to assess whether an applicant can afford a loan. These criteria include the credit record, employment history, residency status (tenant or homeowner), existing debts and net income.

A lender will work out whether or not an applicant can afford to borrow and if so how much they are willing to lend. However, there is also another test to pass. This is the debt to income ratio for borrowers

What Is A Debt To Income Ratio?

Debt to income ratio is worked out by adding up the total monthly debt payments and dividing the figure by monthly income. The result is expressed as a percentage figure.

When a lender works out debt to income ratio, they take into account all your net income and the outgoings from that income from one month. Strictly speaking, the debt part of the equation is not just how much you currently owe. It also includes household bills, transport costs and living expenses. In short, everything that you already spend money on each month.

An Example of Debt to Income Ratio


If recurring payments each month come to £1,250 and your income is £2,500 each month your debt to income ratio would be 50%.

By using this formula, lenders will be able to work out whether you are a good or poor risk. If a debt to income ratio is too high (over 45%), it is unlikely that you will get able to get a personal loan. Most lenders will look for a DTI ratio of 30% or lower.

Affordable Personal Loans: Borrowing Can Change

When you take on a personal loan, there is always the chance of something unexpected occurring. For example, circumstances such as long term sickness or unemployment can occur. A situation like this could leave you with levels of debt that are unsustainable.

So, in addition to looking at your credit history, a potential lender will look at the debt to income ratio. They use this information to evaluate whether your financial circumstances will allow you to repay a personal loan.

How Much Of a Loan Can I Afford?

There are some websites where you can work out your personal debt to income ratio using an online calculator. However, it will only give you a true figure if you put in the correct amounts. It might be tempting to miss out some outgoings on the calculator. Bear in mind; this will only confuse the issue and give you a wrong percentage.

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More importantly, it is a good idea to review whether you actually want to take on a debt. It may last for some years, and it is going to cost you money. Evaluate whether borrowing will merely make your current financial situation worse or better.

Warnings about Brexit suggest that household bills are going to rise in the next two years. Compare the Market said that household costs were a top concern – above immigration and jobs – with many fearing a whole range of bills would rise on Brexit – This Is Money June 2016

If this happens and you have not factored it into your affordability of the personal loan, the results could be damaging to many family’s finances.

Finally, a lender may ask you the purpose of you taking out a loan. In truth, they are not really bothered how you spend the money as long as the affordability factor comes up to their criteria. And, some lenders might bend the rules but charge you a higher rate of interest. You should avoid this at all costs.

Loan Affordability - Personal Loans Now

How Can I Assess My Ability To Pay?

Sometimes taking out a personal loan is a bad idea. For example, if you are earning a limited salary and just getting by but want to take an expensive holiday. This situation would be an example of ‘living beyond your means’. Think about how you would make the extra payments when you return from your holiday.

You can also assess your affordability by asking yourself some questions. Are you expecting a substantial rise in income? Will your current expenditure drop in the near future? Do you expect to get an annual bonus that could pay off the loan? How much are your existing debts and can you really afford to take on another payment?

Giving yourself a thorough interrogation on these types of questions should give you the answer to whether you can afford a personal loan.

Loans That Are Easily Available

There are still a lot of offers readily available for unsecured personal loans despite the last financial crisis when lenders suddenly withdrew from many applicants.

Taking up a personal loan might be the answer to your financial hole.

Loan Affordability - Personal Loans Now

However, take time, pause to work out the true affordability of the product before going ahead with the loan. Taking time now carefully to evaluate the financial situation can help you to avoid blindly rushing in and ending up with some long term debt.

Summary of Loan Affordability

Personal Loans Now talks you through your loan affordability. We questioned whether borrowing is the right move to take should it only be as a last resort. Furthermore, we looked at whether there are affordable unsecured personal loans and the truth about instant approval offers. Next, we looked at how lenders assess affordability and the calculation of debt to income ratio figure. Finally, Personal Loans Now discussed how you should I assess your own ability to repay the personal loan and loan affordability. With all this information, you can ask yourself, should I take out a personal loan?

Loan Affordability - Personal Loans Now