What’s the Best Way to Borrow Money?
Almost everyone needs to borrow money at some point in their lives, be it for a house, education, startup, or even emergencies. Irrespective of your reason to borrow money, there are different ways to get it.
You can either take the help of traditional financial institutions like banks, financing companies, and credit unions or non-traditional sources like peer-to-peer lending, public agencies, and more.
We’ve outlined some of the most popular lending sources below, explaining how they work and their positives and negatives.
Six best ways to borrow money
- Credit Unions
- Peer-to-peer Lending
- 401(k) Plans
- Credit Cards
- Financing Companies
By definition, banks are a traditional source of funds for individuals looking to borrow money. Banks take money (as deposits) and then distribute that money as financing products like consumer loans and mortgages.
Banks also offer other several options to borrow money which include:
- Personal loans
- Auto loans
- Construction loans
- Mortgage products
- Other miscellaneous financing products
Besides this, banks offer opportunities for those looking to refinance an existing loan at a more favorable rate and term.
Positives and negatives of borrowing from a bank
Most people find it convenient to do business with their own bank because they already have a relationship and an account there. Moreover, personnel is usually on hand at the local branch who can help them with paperwork and other formalities. A notary public may also be available to help the customer document some business or personal transactions.
On the other hand, borrowing money from a bank can be expensive. Some banks are notorious for their high costs of loan applications and servicing fees. Furthermore, banks may resell your loan to another bank, causing changes in the fee structure, interest rates, and other procedures, often without prior notice.
2. CREDIT UNIONS
A credit union is a cooperative institution run and controlled by its members (people who use its services). Usually, credit unions include a particular organization, group, or community to which an individual must belong to borrow money.
Positives and negatives of borrowing from a credit union
Like banks, you can get similar offers and services from credit unions. But they are owned by non-profit enterprises, which enables them to lend money at a more favorable rate and on generous terms. In addition, fees on certain services may be cheaper or even non-existent.
On the downside, many credit unions don’t have the variety of loan products some big banks offer. On top of that, you have to join a credit union and open an account with them before you can borrow money.
3. PEER-TO-PEER LENDING (P2P)
Peer-to-peer lending, also known as microlending or crowdfunding, is a process that allows individuals to borrow money or lend money directly from each other without involving any financial intermediaries.
Although microlending removes any involvement of a middleman, the process may involve more time, effort, and risk than an official financial institution.
With peer-to-peer lending, borrowers receive money from lenders willing to lend at an agreed interest rate. Several peer-to-peer lending platforms like Lendee help connect borrowers and lenders, giving them the power to choose what suits them the best.
Positives and negatives of borrowing through P2P lending
A borrower may receive the entire amount or only a portion of it. But if the latter happens, one or more investors in the P2P lending marketplace may be willing to pay the remaining loan amount.
Lenders earn income from the interests their loans generate, and it can often exceed the rates earned through other vehicles, such as savings accounts. Additionally, monthly interest payments on loans can earn lenders higher returns than stock market investments.
P2P loans are a fantastic alternative for borrowers to get money, especially if they have failed to get approval from standard financial intermediaries.
If you consider using a P2P lending platform, it is best to check their transaction fees since they may charge loan origination fees, late fees, and bounced-payment fees, just like banks.
4. 401(k) PLANS
Why not borrow money from yourself when you need it? Most 401(k) plans and other comparable work-place-based retirement accounts, like 403(b) or 457 plans, allow employees to borrow funds in the form of a 401(k) loan.
You’re liable to pay taxes for permanently withdrawing from a 401(k) plan and a 10% penalty if you’re under 59.5 years old. However, you get to avoid that with a 401(k) loan as you’re only taking out the funds temporarily.
Most 401(k)s allow you to borrow up to 50% of the funds vested in the account at a cap of $50,000 for approximately a five-year period. This loan is tax-free since you can only borrow the funds and not withdraw them. Gradually, you pay back the loan, including the principal amount and interest.
Positives and negatives of borrowing from a 401(k) plan
One of the positives of a 401(k) loan is that the interest rates tend to be lower than what you would pay for a personal loan. Additionally, unlike a traditional loan, the interest on a 401(k) loan doesn’t go to the commercial lender or the bank but to you.
Some even argue that the cost of borrowing from a 401(k) fund is more like a payment back to yourself for using your own money. Moreover, there’s no underwriting or application fee on the loan since the money belongs to you.
But this doesn’t mean you can be sloppy with your payments. Because if you do and the IRS finds out, you could be considered in default and your loan classified as a distribution (with taxes and penalties due on it).
An important long-term aspect of this loan is that you lose out on the funds compounding with tax-free interest when you remove money from your retirement plan. Most plans have a provision that forbids you from making additional contributions unless you pay off the loan balance.
So, borrowing money from your 401(k) fund should be your last resort and taken seriously.
5. CREDIT CARDS
In a sense, you use a credit card to borrow money. The credit card company pays the merchant for you, advancing you the money, which you repay the card issuer when your statement comes in.
Other than purchasing goods or services with your credit cards, you can also use them to get actual funds called a cash advance.
Positives and negatives of borrowing through credit cards
A cash advance on a credit card may not be a bad idea to borrow a small amount for a short period. After all, there’s no application fee. Credit cards can be a source of loans at a 0% interest rate if you pay off the entire balance at the end of every month.
On the flip side, credit cards can carry exorbitant interest rate charges on balances carried over. Furthermore, credit card companies lend a relatively small amount of money, which may not be beneficial for those looking for long-term financing to make a large purchase, such as a new car.
Ultimately, borrowing too much money using your credit card can lower your chances of getting loans or additional credit from lending institutions.
6. FINANCING COMPANIES
Financing companies, also known as finance companies, don’t accept deposits or offer other financial products and services, unlike banks or credit unions. They routinely give out loans to individuals and businesses in need of funds.
Most financing companies specialize in short-term loans, and they are often connected to a larger company or a manufacturer, serving as their financing arm.
Positives and negatives of borrowing through financing companies
Financing companies usually offer competitive rates, but a lot depends on your credit score and financial history. Their overall fees can be low compared to banks and other lending institutions. Plus, their approval process is relatively quick.
Unfortunately, financing companies may not offer the same level of customer service or additional services as banks.
Since finance companies are licensed and regulated by the state in which they operate, they are not subject to federal oversight and rules like banks and credit unions. In other words, they are less regulated and have more liberty in adjusting and altering their rates and terms.
There may be multiple avenues to borrow money, but they are not created equal. It is best to carefully evaluate the pros and cons before using the option most suited to your financial situation.
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