The 7 Smartest Ways to Borrow
There are a couple of situations when borrowing money is appropriate. One, when it’s profitable: you earn more with the borrowed money than you pay in interest. Two, when your back’s against the wall, and you simply don’t have a choice.
Last week, we warned you about the dumbest ways to borrow money (some payday loans charge nearly 400-percent interest rates if compounded annually). Today, we explore some smarter ways to borrow. In the video below, Money Talks News founder Stacy Johnson explains the benefits of zero-percent-interest credit cards, margin loans, and more. Check it out and then read on.
Click here to watch ‘The Smartest Ways to Borrow Money’ on MoneyTalksNews.com
Next time you’re thinking about borrowing money, you may want to consider some of these methods. Since everyone’s financial needs and credit standings vary, look for the option that’s the best fit for you.
1. Zero-percent credit cards
Back in February, we mentioned that credit cards with zero-percent interest rates and no-fee balance transfers were making a comeback. Just this month, credit cards with zero rates are again making headlines. These cards offer “teaser rate” incentives with grace periods from six to 18 months.
These promotions are typically for purchases or balance transfers only, not cash advances. After the card’s zero APR period expires, interest rates can be as high as 25 percent. So while the zero percent is by definition the lowest rate you can get, these credit cards are short-term solutions.
2. Mortgages
A second mortgage or home equity line of credit allows you to borrow longer-term, is potentially deductible, and offers rates as low as 4 percent. But it’s important to understand the risk: fail to pay and you could lose your home.
As the name implies, a second mortgage resembles a first: you borrow a fixed amount, often at a fixed rate, and have a level monthly payment until it’s paid off. A home equity line of credit acts more like a credit card: you’re approved for a certain amount, and draw on it as needed. Like a credit card, the interest rate is generally variable and your payment is based on the amount outstanding.
Second mortgages are generally the way to go when you have a large lump-sum expense, like a major addition to your home or college tuition. A line of credit would be more appropriate when you won’t need all the money at once, or may need to borrow some, pay it back, then borrow more.
In either case, be sure to read the fine print, focusing on rate and fees, and do lots of comparison shopping.
3. Margin loans
Margin loans use securities like stocks, bonds or other securities as collateral. This allows you to put up only half the money when you buy stocks, or borrow half of your stock’s value whenever you’d like. One caveat: retirement accounts aren’t eligible for margin loans. Rates vary by company and the size of the loan. Online brokerage firm Scottrade’s range, for example, is 5.25 percent for loans over $1 million to 7.75 percent for loans less than $1,000.
As long as you earn more than you pay in interest, a margin loan will be profitable. The big risk comes when your securities drop in value, resulting in the infamous “margin call.” Should your stocks fall by a certain amount, the brokerage firm calls you for more money. Fail to cough it up immediately and they’ll liquidate enough shares to get it.
4. 401(k) loans
If you have a retirement plan, you might be able to borrow from it. Companies’ limits vary, but account holders can often borrow up to half of their account balance, at a maximum of $50,000. Rates can be low, and the best part is that you’re paying interest to yourself.
Your employer may restrict lending criteria, or not offer loans at all. But if borrowing is an option, this move comes with some caution. If you quit your job or get laid off, you’ll have to repay the loan, usually within 60 days. If you can’t, income taxes and penalties will result.
5. Borrowing from family or friends
Enlisting help from family or friends can be one of the worst ways to borrow money. In fact, we said so just last week in our list of The 7 Dumbest Ways to Borrow Money. However, this can also be a smart way to borrow – if the circumstances are right and proper precautions are taken.
For borrowers, it’s financially the safest kind of debt, since you don’t have to worry about hidden fees or surging interest rates. On the other hand, you want to be confident that borrowing doesn’t put a strain on your relationship. To make sure you’re all on the same page, draft a legal document specifying rates, terms, and due date. Keep it as official as possible to keep your relationship intact.
6. Peer-to-peer lending
In a recent post, we explained how peer-to-peer lending offers an opportunity as an investment. It might also be a good way to find lower-rate loans.
Borrowers can search for a lender on sites like Lending Club or Prosper. The rate of interest you’ll pay will depend on your credit – if your credit score is very low, you may not be able to borrow this way at all. But if you’ve got a good credit score and need a small, short-term loan, peer-to-peer can beat the banks.
7. Credit unions
Credit unions offer flexible lending and lower rates than banks. As we explained in Credit Unions: Better for College Students – and Many Others, according to DataTrac, the average credit union rate on a car loan is 1.5 to 2 percentage points lower than at a bank, and home equity lines of credit average about half a percentage point lower.
Credit unions might also offer signature loans – an unsecured loan guaranteed only by your signature. Obviously, you’ll need membership and good credit, but this can be a good source of short-term cash.
Bottom line? There’s no one-fits-all solution when it comes to borrowing money, but by carefully considering your options, you’ll increase your chances of finding a plan that works best for you.
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