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Loans: what is the risk?

December 2nd, 2008 by jamie | Filed under Daily News, Debt, Loans, Mortgages, Recession.

Without loans and credit, the world would not have advanced so much since the second world war. Arguably, people would still be yoked to a agricultural based economy and we would still be doffing our caps to the local landowners. 

But now, at the time of writing, it’s obvious that too many loans and too much credit can have a bad effect as well. Simply, when money gets tight and credit gets tight, people cannot expand as they once did, both personally and in business, and things start slowing down. Then the trouble starts.

But the fundamental principle of a loan remains sound. Someone, or something, has spare money which they can use more productively than putting under the bed, or getting a low savings interest rate, by loaning someone else for a higher interest rate. Everyone’s a winner.

And even in economically challenged times, all loans just don’t stop. The world keeps spinning and money keeps moving. And although the UK mortgage market has virtually collapsed (at the time of writing), this really is based on new mortgages; re-mortgages are still being written.

Now, in goods times when lots of money is around, there are usually lots of loan opportunities around. Ironically, when bad times hit and money is sparse, and arguably, loans are needed more, opportunities are harder to come by.

And now we also have a new financial term called sub prime. In the last boom it became obvious that with clever marketing, financial institutions had in many respects exhausted the mine of people that could well afford, mortgages, loans, pensions and finance deals. They had been tapped out. So, a new rich vein of opportunity was needed and thus the sub prime sector was invented. Looking back of course with 20/20 hindsight, the financial services sector was just building a time bomb which would eventually explode, but with the bonus culture at full pelt, who was going to cry foul? So, people who could barely afford to survive from month to month, were offered mortgages to buy their own homes. The pack of cards soon began to wobble when, en masse, these people handed back their keys and the sub prime lending panic was upon us. And low and behold, the institutions had happily sold these mortgage liabilities to all their friends, meaning that great banks and financial bodies were all holding a piece of the bomb.

Right, so now we are in a new economic climate with loans few and far between. And the big question, are they worth the risk?

For some there may  be no choice. If you have a business, or a personal financial situation that requires regularly funding, you cannot just stop. You have to try and arrange new funding and even if you succeed, you might find the new interest rate punitive.

In many respects, running a business, or trying to keep afloat, necessitates loans and credit supply, so pat advice saying do not get further geared (the amount of credit you might have) is not helpful. For some people, it’s a question of keeping the whole show on the road until good times return. And they will. If there’s one thing that history has taught us, it’s that the boom and bust culture has never left us, despite assurances from the politicians. 

But if you are looking for a loan, or mortgage for the first time, and it’s not a matter of life and death, think really hard about whether you can afford it. Take a critical look at your finances, consider the doomsday scenarios (redundancy, illness) and if you feel comfortable with those, then go ahead, if you can.

And also have a quick look over the abyss, make sure you know what happens if you default on a loan. On a secured loan, you default and you can’t renegotiate the terms, then the security that backs the loan is lost to you. But even if your loan is unsecured, the lender can still take you to court, and force a County Court Judgment against you, which in effect, means a ruined credit record and little chance of future loans for at least six years, if not for a lot longer than that.

So the risk of getting a loan can be great; it really comes down to whether you can afford it, or not, and what happens to you if its goes wrong.

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