The best and worst ways to borrow money
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If you’re like most people, chances are you’ll need a loan at some point to make ends meet.
Over the past few decades, Americans have taken on mounting debt to get by. About 80% of U.S. households now hold some form of debt, according to Pew Charitable Trusts survey of American family finances. And less than half, or 46%, said they earn more than they spend.
But when you’re short on cash, not all types of borrowing are created equal. Here are some of the best and worst loans available.
Credit cards are one of the most common – and also one of the most expensive – ways to borrow money. Since card issuers charge much higher interest rates than other types of lenders, a credit card balance can quickly spiral out of control.
Currently, credit card rates are at an all-time high, averaging around 17%, according to Bankrate, and the average American has a credit card balance of $6,375, up nearly 3% compared to last year, according to Experian’s annual study of the state of credit and debt in America.
According to Greg McBride, chief financial analyst at Bankrate.com, good credit card management comes down to making payments on time and relying on revolving credit only in limited situations.
If you’re considering a major purchase, such as a major appliance, a no-introductory credit card offer could be a great way to get a short-term, interest-free loan, as long as the purchase is paid off when the time period comes. introductory ends, he said.
Otherwise, only buy plastic items that you can afford to pay back at the end of the month.
Before the Great Recession and the historic real estate crash, homeowners used their homes to access as much money as the bank would allow. But borrowers who have been burned by falling house prices, not to mention today’s tougher lending standards, are much more wary now about home equity loans and lines of credit. , despite the more favorable conditions.
Yet the amount of net worth today’s homeowners can tap into is the highest level ever recorded.
One of the most common ways to tap into this equity is through a cash refinance (i.e. when you refinance your current mortgage and take out a larger mortgage) or a home equity loan. .
A home equity loan can be taken out as a fixed rate lump sum with a repayment period of typically five to 15 years or as a variable rate home equity line of credit.
The average interest rate on a home equity loan is 5-6%, but under the new tax law the money must be used to improve your home, otherwise the interest is not tax deductible.
Personal loans, or unsecured loans, don’t require you to borrow against something of value, like a house, which makes them especially attractive to those who don’t have that kind of equity. However, this generally means that the loans are available at a higher interest rate than a home equity loan.
Personal loans are also locked in for shorter terms, such as one to five years, and payments are usually automatically deducted from a checking account, reducing the risk of missing a payment or defaulting.
Personal loans are well suited for smaller loan amounts than a typical home equity loan, but more than one would want to rack up credit cards – typically up to $35,000.
A number of online lenders, like Lending Club and Prosper, have popped up in recent years to offer these types of loans as another way to borrow money, especially for millennials who want to consolidate debt but don’t don’t have the equity in their home for a secured loan to do that.
The average interest rate on an unsecured loan is currently around 11%, according to Bankrate, although those with very good credit can get as low as 5.5%. That’s significantly less than the APR on a credit card.
There is a significant downside to borrowing from your own retirement account. “A 401(k) loan sounds innocent enough, but it’s a permanent setback to your retirement planning,” McBride said.
“You are spending resources to replace money you have borrowed instead of making new contributions, and you are missing out on potential capital gains, dividends, and interest income over the life of the current loan.”
Also, if you leave your employer, by choice or otherwise, the loan balance will be due within 90 days.
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