The 3 best (and 3 worst) ways to borrow money, ranked
The fact is, almost everyone will need to borrow money at some point. Home prices are up 44% from two years ago, and while prices are trending down, buy a house now is still very difficult for most Americans, forcing them to take out a loan. Whether or not we’re in a recession is on everyone’s lips with economists, pointing to another reason why Americans might need extra money they don’t have on hand.
Borrowing money isn’t a bad thing to do, and there are ways to do it that will actually help your financial portfolio. Of course, there are also ways to borrow that could send you into a mountain of debt. Here is a list of ways to borrow and their ranking in terms of risk and reward.
Best Borrowing Methods
There are different types of mortgages, but they are all loans from a bank used to buy real estate. Because a bank is FDIC insured, it is a safe bet for lenders. As a borrower, you apply for the type of mortgage you want and then agree to pay a principal amount plus an interest rate over time. The property you bought with the mortgage serves as collateral, so if you don’t meet your payments, the bank becomes the owner of your home.
This is an extremely common way to borrow money, as 42% of US households are paying a mortgage on their home. Because getting a mortgage involves a bank, you’ll have access to assistance to help you through the process. The downside of working with a bank is that there are often additional fees associated with the application process, and your loan can be transferred to another bank at any time.
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2. Personal loans
Personal loans are also acquired from your bank and can be used for any purpose. What it costs you as a borrower depends on your credit score and the policies of the lender. No collateral is collected for personal loans, but if you miss payments or fail to repay the loan, your credit score is affected and could prevent you from receiving loans in the future. There are also interest and processing fees associated with personal loans.
Like mortgages, personal loans are very common. More than 20 million Americans owe money on personal loans.
3. Borrow from your retirement plan
You may have heard that it’s not a good idea to withdraw money from your 401(k) or 403(b) account, but borrowing is another story. A retirement plan loan means that you borrow money from your retirement account and pay it back with interest over time. There are no tax penalties because you agree to repay the money. Conversely, a withdrawal from a retirement plan means that you have no intention of paying that money back and therefore you will have to pay additional taxes and fees.
The Worst Borrowing Methods
1. Payday Loans
When people need money fast, they sometimes opt for a payday loan. The problem with these is that the interest on them is extremely high compared to other loans, and the principal amount is based on your income. Due to the high fees and interest associated with these loans, they have been branded as predatory. They have actually been banned in 12 states. They can easily create more debt for the potential borrower.
2. Cash advance by credit card
If you have a credit card, you’ve probably noticed that there’s an option to get a cash advance using the card. There are transaction fees that depend on the amount you are looking to get in cash. These fees can be between 3% and 5% of the amount. In addition, there is interest to be paid, which can go up to 25%. It ends up being an incredibly expensive way to borrow money.
3. Automatic securities lending
These loans use your car as collateral. When you take out the loan from an auto title lending company, you give them the deed to your vehicle. In addition, you will pay a fee of up to 25% of the amount for which you take out a loan. If you don’t pay on time (which is usually around 30 days), the company may repossess your car, depending on the terms of the loan. Many people who take out auto title loans end up taking out multiple loans in order to be able to pay off the previous loan, creating a huge cycle of debt.
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