When is it a good or bad idea to take out a loan?

Financial advisers reveal the key things to consider before taking a loan.

Experts explain when you should and should not take out a loan (Alamy/PA) (Alamy/PA)

As the UK experiences a cost-of-living squeeze, it’s never been more tempting to borrow.

Loans can smooth out big life purchases and spread the cost of essentials, but they can just as easily deepen money worries if they’re taken on for the wrong reasons or without a realistic plan to repay them.

So, when does borrowing make sense? And when should you step back?

When a loan can be the right financial tool

Loans aren’t inherently bad, explains chartered tax adviser and private client consultant at St. James’s Place, Obi Nnochiri, who also says the key is what you use them for.

“Taking out a loan can make financial sense when it is used to fund something that provides long-term value or improves financial resilience,” he says, “such as buying a home, investing in education or skills, consolidating expensive existing debt or covering a short-term cashflow gap with a clear repayment plan.”

Nnochiri’s last point is crucial. A loan should support stability – not postpone a financial crisis.

Money Wellness‘ external relations director, Sebrina McCullough says a loan “can make sense if it genuinely improves your situation in the long run […] Where people often come unstuck is borrowing to plug a gap that’s really about ongoing affordability.”

Her team regularly hears from people who have used credit simply to cover everyday bills. That, she warns, “is usually a sign borrowing will make things harder, not easier.”

Borrowing for education, a home or to consolidate more expensive debt can be rational – provided the repayments are sustainable. Borrowing for a holiday or lifestyle upgrade is harder to justify unless you could comfortably afford the repayments even in a bad month.

When loans do more harm than good

Financial experts are all in agreement that borrowing becomes risky when people use it to maintain day-to-day spending or fund non-essentials.

As Nnochiri puts it, “borrowing should generally be avoided when it is used to fund day-to-day spending, or non-essential purchases, particularly if repayments would be difficult to maintain or rely on future income increases.

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“If borrowing is needed simply to keep up with regular bills, that can be a sign of deeper financial pressure and should be addressed before taking on further debt.”

In other words, if you’re borrowing to stand still, the problem usually isn’t the lack of credit – it’s an affordability gap that won’t be solved by another repayment.

High-cost credit is an even bigger red flag. McCullough describes payday-type loans as “a major red flag” that “can look like a quick fix, but we often see them pull people into a cycle of borrowing.”

Look beyond the monthly repayment

One trap is focusing only on the monthly figure rather than the overall cost.

Nnochiri warns that “before applying for a loan, people should look beyond the headline monthly payment.”

Interest rates, whether the rate is fixed or variable, and the length of the term all change what you pay over time – sometimes dramatically.

“A lower monthly payment over a longer term can feel more affordable,” agrees McCullough, “but it often means paying much more overall.”

Checking your credit file before applying can also prevent surprises – repeated rejected applications can make approval harder next time.

Work out whether you can really afford it

Both experts stress the importance of a realistic household budget. That means including everything – bills, food, existing debts, childcare, petrol – not just the “big” costs.

Nnochiri says “a realistic affordability assessment starts with a detailed household budget […] people should also stress-test their finances by asking whether repayments would still be affordable if interest rates rose or their income reduced.”

Relying on overtime or hoped-for promotions is risky. As he puts it, “loan repayments should comfortably fit within your budget, not stretch it.”

McCullough suggests viewing your budget as a resilience test. “Ask yourself whether you’d still cope with the repayments if your bills went up, your income dropped, or things didn’t go to plan.” If the answer is no, you may be setting yourself up for stress later.

Already in debt? Pause before borrowing more

If you’re already juggling repayments, another loan shouldn’t be the first instinct.

Nnochiri advises people to review everything they already owe and focus on clearing the most expensive debts first. If repayments are slipping or credit is being used simply to stay afloat, he says “it’s important to seek help early.”

That help does not need to be expensive. McCullough recommends speaking to a free, impartial adviser.

“Getting support early can stop a short-term money problem from turning into something much harder to deal with.”

So, when does borrowing make sense?

If a loan gives you something lasting – a qualification, a home, or a way of reorganising expensive debt into something manageable – it can be a rational financial choice.

If it pays for things that will be gone long before the loan is, or if the repayments only work when everything goes perfectly, the risk rises sharply.

Perhaps the simplest way to see it is this: debt should serve your long-term life goals. If it doesn’t – pause, get advice and ask whether there’s a better route.