We teach kids not to take candy from strangers — maybe adults could learn the same lesson about money from lenders.
If you’re getting offers of money you didn’t ask for — from student loans to home equity lines of credit — it may be tempting to take the money as a short-term fix for other money woes.
But if you’re relying on money you hope to have to pay off the loan — whether it’s anticipating a six-figure salary at graduation or assuming you and your partner can combine finances to cover the minimum payments — you could be setting yourself up for disaster by accepting money that you don’t necessarily need.
Here’s why you should be wary about accepting (then owing) more than you can afford.
4 Times You Should Say No to Loans and Other Money Offers
Why would lenders offer you money if they didn’t think you were good for it?
Because it’s in their best interest (ha!) to entice you to accept the most money possible. After all, the more money you take, the more money (and presumably interest) you’ll have to pay back to the lender.
But when you’re looking at an offer, how can you know how much is too much? And are there scenarios when you should accept money you didn’t ask for?
We’ve come up with four financial situations when it’s better to just say no to money.
1. Home Equity Loans
Before you’ve even finished unpacking the boxes in your new home, you’ll start getting those letters in the mail — you know, the ones that shout (because they always shout) that you could use the equity in your home to pay off credit card bills! Go on vacation! Order Uber Eats! (OK, maybe not the last one.)
And you might think to yourself: I already have the house, and it isn’t going anywhere, so why shouldn’t I take the extra cash to pay for new tires on the car?
But although you may consider your place home sweet home, you should view your house as the commodity it is — not something with a permanent, constant value but one that’s as susceptible to market volatility as stocks.
“Just because home values have increased and you do have access to the equity in your home, it doesn’t mean it’s real,” said Ariel Ward, Certified Financial Planner at Abacus Wealth Partners. “And just because the access is there to the equity doesn’t mean you should take it.”
The point of a home equity loan — at least in theory — is that it’s supposed to be money you can draw from your home’s value to improve the home and thus increase its value.
“There are situations where it might make sense — like you are going to add square footage to your home — where you’re actually increasing the value of your home,” Ward said. But she still recommended retaining at least 20% equity in the home, “and if you can keep at least 30% equity, that would be ideal.”
Just because the access is there to the equity doesn’t mean you should take it.
But if you use money from a home equity loan for anything else, you are potentially setting yourself up for owing more on your house than it’s worth.
“[If] you used the money to buy things that did not improve the value of your home, and then you need to sell your home because you lost your job or your company is relocating you, you could be putting yourself in a very poor financial situation,” Ward said.
2. Student Loans
Student loans are designed to cover the cost of college and can be viewed as money that will provide a return on investment through a high-paying career. Simple enough.
Well, not to go all Philosophy 101 on you, but how do you define the “cost of college”? Is it just tuition, fees and books? Or should that number include housing? And transportation? And pizza?
Those expenses — and the offers of easy cash — can be overwhelming for someone out on their own for the first time, according to Certified Financial Planner Holly Donaldson, founder of Holly Donaldson Financial Planning in St. Petersburg, Florida.
“People often think: I’m getting a loan, it’s going to cover my tuition and my room and board, but in fact what people get approved for would cover many kinds of extra living expenses,” she said.
Unfortunately, those first-time borrowers assume the only way they could be approved for the loans is because the bank knew the student could repay it.
”It’s a common mistake,” Donaldson said.
With all those offers pouring in, it’s no wonder that consumers with educational debt had an average of 3.7 student loans, according to a 2017 Experian report.
Unfortunately, the debt can accumulate quickly and might not be so easy to pay off if you didn’t snag that six-figure job offer you were banking on — just ask the people who currently hold $1.48 trillion in outstanding student loans.
Instead of accepting any offers — even Federal Student Loans — students should figure out exactly how much they need to cover the cost of education, then factor in what they might need on top of that before considering student loans for living expenses.
“It would be really good for the student to sit down with their parents and make a budget before they go to school,” Davidson said. “Allow yourself Friday nights or fun times, but just know that it’s all going on the student loan.”
(Psst. We have a Penny Hoarder cheat sheet for budgeting for college.)
And instead of starting with student loans, consider creative ways to pay for college without going into debt — scholarships, work-study programs and part-time jobs all offer you money that you don’t have to pay back.
Although these options may not cover every cost, using resources other than student loans to pay for expenses other than tuition reduces the amount of debt you’ll be paying back long after your dorm days.
“You could use your student loans for room and board or transportation to and from school, and that’s where some of the students have told us that things went south,” said Melinda Opperman, executive vice president of Credit.org. “They realize now that they’re going to spend decades to repay it.
“In hindsight, they wished they had… taken on a part-time job to pay for some of those things and wished they had only used the student loan truly for the tuition and books.”
3. Auto Loans
You walk in the dealership prepared to buy a used Honda Civic, but you walk out with a Brand. New. Audi!
OK, that might be a bit extreme, but auto dealerships typically make more money from finder’s fees for the loans than the car itself, so it’s to their benefit to get you in the best car possible.
And if you object that the car seems out of your league? Don’t worry, the dealer tells you, they can get the monthly payments down to something you can afford.
What they don’t tell you is that often means you’ll be signing for longer-term car loans — up to 96-month loans (that’s eight years) — to reduce the monthly payments enough to get you to sign.
And that means you’ll pay so much in interest over the life of your loan that you’ll end up forking over hundreds — or even thousands — more for those wheels. Plus, your car may be worth less than you owe before you send the final payment.
An auto loan preapproval is a financing offer from a lender that includes the maximum loan amount, APR and terms of the loan. It can give you negotiating power when shopping for a car.
One easy way to avoid becoming overwhelmed on the car lot and being talked into a vehicle you cannot afford: getting an auto loan preapproval.
A preapproved loan alone doesn’t guarantee you won’t still get more money than you should accept, but it gives you the opportunity to figure out your budget, including how much car you can afford and what else the loan may need to cover (title, tax, insurance, for instance).
By bringing that offer with you into the dealership, you’ll have a clear picture of how much you can afford, then compare that offer to what the dealership offers.
And if you’re still feeling pressured to upgrade?
“Before walking out with a different car than what you had figured out you could afford, pause, take a breath, tell them you’ll come back later and call your financial planner,” Donaldson said with a laugh.
4. Credit Card Limit Increases
Your credit card company calls… with good news! (How often does that happen?) They want to extend your credit line. You puff up your chest just a little bit because, man, you must be doing something right, right?
The credit card company is potentially rewarding you for good behavior — like paying your bills on time — but it could also have noticed you got a little close to your limit recently. Rather than suggesting you cut back, the company instead gives you more credit.
And regardless of the reason how you qualified for an increase, the credit card company’s ultimate goal is to get you to spend more money on their card so it can make more money off of your account from fees and interest.
So should you increase your credit limit if offered?
There’s a good reason to take it, but only if you can trust yourself.
It’s not like the company is handing you money that you’ll have to repay, as with loan offers.
Instead, this increases the amount of money available to you, which could improve your credit utilization ratio — the amount of debt you have compared to the amount of credit you have available.
A good ratio is typically less than 30%, but if you want to increase your credit score, it’s best to keep that ratio under 10%.
So if you put $700 on a credit card with a $2,000 limit, your credit utilization ratio would be 35%. But if you put $700 on a credit card with a $5,000 limit, your ratio would only be 14%.
If you never accrue enough charges to get near your credit limit, that increase could be a boost for your credit score.
So take the offer, right?
Well, only if you’re able to look at the increase, then forget about it. But if you see the new limit and think, “It’s time for a vacation… and a shopping spree,” you might want to consider asking the company to take it back.
“You don’t always have to accept the credit limit that they’re willing to give you,” said Certified Financial Planner Lauren Anastasio, a wealth advisor at SoFi, a personal finance advisement company.
She suggested that if the higher limit makes you nervous, call the credit card company and ask them to lower your credit limit to an amount you feel comfortable that you could pay if you did happen to reach your new threshold.
Remember: You’re in Charge
Regardless of what the offer is, it’s important to remember that lenders are in the business of making money, not helping you. So have a clear picture of finances before making a decision to accept any of their offers.
“You should not be trusting the financial companies and not trusting the banks to determine what is affordable to you,” Donaldson said. “You’ve got to determine what’s affordable to you.”
Tiffany Wendeln Connors is a staff writer/editor at The Penny Hoarder. Read her bio and other work here, then catch her on Twitter @TiffanyWendeln.