Many of the articles on this website focus on helping people to get out of debt, but credit is not necessarily a bad thing if you understand how to borrow responsibly.

In personal finance, we often talk of “good” debt versus “bad” debt. Typically, we consider an asset-backed loan ‒ such as house or car finance ‒ to be acceptable debt, whereas debt that we take so that we can spend on consumption goods, is frowned upon. Consumption debt is usually put on our credit cards or store cards.

Recently I was asked by a young woman, who was just starting to work, whether she should borrow money to pay the deposit on her rented accommodation. She was about to receive her first paycheque but needed to pay the first month’s rent plus a deposit on her apartment. She did not have the funds available.

This is an example of how short-term credit can be useful, if managed carefully.

What can you afford?

In this woman’s case, the starting point would be to do a proper budget to ensure she could afford the apartment.

When you start working and leave home, you may not be used to the true cost of living and may be tempted to overcommit to living costs like a rented apartment.

Once you’ve drawn up a proper budget, which includes the rent, electricity, food, transportation and spending money, then you would have a good idea whether the apartment would be sustainable.

If the numbers work for the apartment, and all that is needed is some extra cash for the deposit, then you can start looking at what you can afford in terms of monthly loan repayments.

Borrow only what you need

When you apply for a loan, the credit provider will most likely encourage you to take the maximum amount you qualify for.  This can be tempting, but remember that you will have to pay back the full loan, together with interest and fees.

Only borrow for a specific purpose and only borrow the amount you need, not more.

Avoid loans that have a revolving credit facility. These are flexible loans that enable you to draw down funds and then repay it and withdraw again. These do not have a fixed term so you can find yourself permanently living in credit and often using it for lifestyle reasons.

The cost of the loan

Make sure you understand the total cost of the loan. Apart from interest, one will be charged an initiation fee and monthly service fee.

The initiation fee is added to the loan amount and can have a significant impact on the monthly repayment amount. The credit provider may also add on other costs such as credit insurance. You have the option to negotiate this and use existing insurance.

It is important to note that on loans with a duration of less than six months, the credit provider can charge an interest rate as high as 5% per month, which works out at 60% per annum.

However, on a personal loan of six months or more, the interest rate is capped at 21% above the repo rate which would currently be 29.25% per annum. This will have an impact on the cost of your loan, so it is important to find out what interest you will be charged.

You can negotiate your interest rate and shop around for the best deal, but always ask for the total cost of the loan so that you can make a proper comparison.

You then need to select a repayment period that ensures you settle the loan in a reasonable time frame without putting yourself under too much financial pressure.

In this case, as the table below shows, the three-month loan has a similar total cost to the six-month loan. However, the monthly installment on the six-month loan is more affordable, in which case it could make sense to take the six-month loan.

When comparing a six-month loan to a 12-month loan, while the installments are lower for the longer-term loan, the total cost increases by more than R1 000. This is where paying off debt sooner can make a big difference.

Tips to help you borrow responsibly

• Ask questions so that you understand all the cost implications before taking a loan.
• If you make the decision to take a loan for a specific need, make sure you pay it off before you take on any other debt.
• Do not create a habit of using short-term debt to finance your lifestyle. That is where the debt trap starts.

This article first appeared in City Press.