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Let’s get personal: Everything you need to know about personal loans

Be great to have a holiday, wouldn’t it? Or start those renovations, or book that dreamy wedding venue… the one with the five-star view over the vineyards.

Whatever it is, an extra $10k, $20k or even $50k to help you make it happen sounds nice, no?

Short of coming into an inheritance or winning the lottery (now that would be nice), there’s just one place you’ll find that sort of money. Let’s talk personal loans, and if that $20k you want now is something future you is going to thank you for.

What is a personal loan?

A personal loan is a loan from a bank or other lender for ‘personal’ things like a holiday, a wedding, renovations, or debt consolidation. They’re typically taken out with a term of 1-7 years.

There are two options available:

  • Fixed personal loan: where the interest rate on your loan is fixed for the entire term and your repayments do not change. They’re not very flexible, meaning there’s usually an early termination fee for paying it out early.
  • Variable personal loan: whereby the interest rate rises and falls with the market. The flexibility means you won’t attract a fee for paying the loan off early, which is nice of them, but if the interest rate rises your repayments will too.

Oh yeah, and of course we can’t forget about the pesky interest rates. That’s catch one.

Oh yeah, and of course we can’t forget about the pesky interest rates. That’s catch one.

Catch one: The interest

The rates associated with personal loans are sky high, and so are your repayments.

So, how much is that holiday/wedding/renovation going to cost you over time?

Let’s take a look*:

Loan amountLoan term / interest rateMonthly repayment
$3,000 holiday5 years @8.90% variable$64.18pm
$10,000 debt consolidation loan5 years @6.99% Fixed$210.93pm
$25,000 wedding5 years @8.90% variable$519.80pm
$50,000 home renovations5 years @6.99% Fixed$1002.79pm
*Based off a 8.90% interest rate with a 10.28% comparison rate. Rates correct as of 21 March 2023.

So that $3,000 holiday? Is actually going to cost you close to $4k. The $25,000 wedding? More than $30k. Ouch.

Catch two: Your future home loan

Would you like to own your own home one day? Unless you’ve already secured one – or plan on renting or living with your parents forever – you probably want to pay attention to this.

When you go to the bank for your home loan, they’re going to look at any existing debt you have and reduce your borrowing capacity accordingly. Which can feel a bit harsh.

If you’ve got a personal loan to pay off, they might offer you significantly less money than you need to buy your home. Or refuse to lend you anything at all.

It works like this:

  1. The bank assesses how much you earn. The higher your income, the higher your borrowing capacity is.
  2. The bank assesses what you already have owing. Things like credit cards, HECs debts, car loans, personal loans and even your Afterpay purchases (more on that one here ). The more you owe, the more your income (aka, your borrowing capacity) has been diminished to cover them.
  3. The bank will also check how many applications for finance you’ve made over the years. The more credit cards, car loans and personal loan enquiries you’ve made, the lower your credit score. Regardless of whether you took out the loan or not.

The higher your incomings (income) and the lower your outgoings (debt), the more you can borrow. Take a look at it in action:

Single applicant with no dependents earning $75,000 a year with no personal debt = borrowing capacity of $352,000*.

Single applicant with no dependents earning $75,000 with a $5,000 credit card limit = borrowing capacity lowered to $331,500*.

Single applicant with no dependents earning $75,000 a year with a $5,000 credit card limit AND a $25,000 personal loan with repayments of approx. $519.80 per month = borrowing capacity lowered to $247,400*.

*Based on a 5.99% interest rate with a 6.37% comparison rate over 30 years. Rates correct as of 21 March 2023.

See the difference? One small credit card and a personal loan and almost $100,000 has been wiped from your borrowing capacity.

Bonnie’s wrap

Personal loans sound great.

“I can go to The Maldives this year?”
“We can get married at that winery we love so much?”
“New bathroom, who dis?” 🛀

But it’s important to stop and think about your long-term goals and if taking out a personal loan is going to get you nearer or further from them.

Is that holiday something you can save up for and take next year instead? And be sure to look ahead… do you want to be paying it off in five years’ time, when your two-week holiday i[BR1] s all but a distant memory?

And most importantly, do you want to put your future home loan at risk?

We’re not saying never. There’s a time and a place for a personal loan. But if buying a home is one of your goals then now might not be that time.

I understand that financial emergencies do happen from time to time and a personal loan may be the only solution, but if you can avoid them, I highly encourage you to do so.

(FYI: almost everything we’ve just told you about personal loans goes for car loans too. So if you’re in the market for a new set of wheels, do us a favour and read this first).

Related to: Loans low down
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