Though an emergency savings fund is the ideal source of funds to tap when unexpected expenses arise, sometimes it’s necessary to look beyond your savings account for assistance when life throws you a curveball.
There are many options to choose from when it comes to borrowing money, and some forms of borrowing offer advantages that outweigh the disadvantages.
So do your research and carefully assess the risks before deciding on a borrowing option. Also, whether you’re looking for the best rate or need cash fast, it’s always best to be very specific about what you need the money for so you know the best borrowing option when you see it.
In addition to specifying the purpose of the loan, you should also consider the following:
- What is your preferred loan repayment period?
- How much interest are you willing to pay?
- What are your current credit score and credit history?
- Is the money you’re thinking of borrowing intended for something you need or something you want?
Once you’ve answered these questions to the best of your ability, you can consider the borrowing option that’s best for you. Let’s take a look at the top ways to borrow money.
1. P2P Lending
Peer-to-peer lending, also known as crowdlending or social lending, allows individuals to borrow from and lend to each other directly. P2P lending can be a great alternative source of funds for borrowers who cannot obtain traditional financing.
People borrow money from each other through peer-to-peer lending platforms, usually at a fixed interest rate, and the lender generates income from the interest on the borrowed sum. These sites allow lenders to evaluate borrowers to decide whether to extend or decline a loan or perhaps fund only a portion of it.
2. Traditional Bank Loans
Traditional banks are a good source of funds for people who need money to purchase a new home or pay for college tuition. Banks offer several financial services to consumers – especially if they’re existing customers – such as refinancing opportunities. And bank personnel are usually available to answer questions and assist with paperwork.
The disadvantage to borrowing from a bank is the high interest rate. Banks charge much higher interest rates on loans than they charge on deposits because they’re assuming a risk. Generally, banks also charge high application and servicing fees for loans, and they cannot guarantee the predictability of your repayment plan because loans are often resold to other banks or financing companies.
3. A 401(k) Plan
Most workplace retirement plans allow employees to borrow from their 403(b) and 401(k) accounts under certain “hardship provisions.” If you are experiencing what the IRS calls “an immediate and heavy financial need,” you can borrow up to 50% of your 401(k) account’s vested funds for up to five years – up to a limit of $50,000. Since you are borrowing funds rather than withdrawing them, it is a tax-free loan. As such, it can be repaid gradually with principal and interest.
One thing to remember with this type of loan is that you will have to repay it with after-tax dollars, so you may lose investment earnings on the funds while they are out of the account. That said, it can be an attractive short-term loan because it can be the fastest and lowest-cost way to get money – and it has no impact on your credit score.
4. A Credit Union
Credit unions are cooperative, nonprofit institutions controlled by their members, and offer membership-only services similar to those provided by banks. Traditionally, credit union membership was restricted to employees and members of specific organizations, communities, or unions. Many have recently loosened membership restrictions and opened their doors to the general public.
Usually, credit unions can offer better terms and interest rates than commercial banks because of their nonprofit status, and they may even be able to charge much lower fees for loan applications.
5. A Credit Card
Credit cards work just like debit cards when it comes to borrowing money. The credit card company advances a loan to merchants, essentially providing them with payment for the goods you’re purchasing. You can also use a credit card to withdraw cash, which is known as a cash advance and does not require an application fee.
If you pay off your credit card balance each month, you’ll likely be able to obtain a 0% interest loan. But, be aware that if a balance is carried over, credit card interest rates can climb to over 20% annually. Also important to note, credit card companies lend only small amounts of credit, so large purchases – like a house or a car – are not feasible using this method.
6. Financing Companies
Simply put, finance companies lend money to individuals – most commonly to purchase cars, furniture, and appliances – and are licensed and regulated by the states, not the federal government.
When determining your interest rate, financing companies consider your credit score and your financial history. In most cases, retailers handle approvals which are completed relatively quickly.
7. A Public Agency
Funding can be obtained from several government agencies and nonprofits, which can also help borrowers repay their loans over time. Government agencies usually charge less for loans than private institutions, though they often require high-income levels and asset requirements, so obtaining a loan from them can be rather difficult.
While borrowing money might incur interest rates and extra payments, most people will find it necessary at some point in their lives. Even wealthy people started their journey to wealth creation by borrowing money for certain investments.
As with most finance-related scenarios, it isn’t about the financial tool itself but more about how people use it. Borrowing can help you get back on track financially, pay for unexpected expenses, or help you to create long-term wealth. There are precautions to take when borrowing money to ensure that you don’t end up underwater. Your financial circumstances, short- and long-term needs, and ability to repay borrowed money are critical factors to consider.