Emergencies are inevitable and even after setting aside money for this reason, you may need to dig deeper into your pocket to preventan emergency from becoming worse. One of the ways includes borrowing, and with many Americans living from paycheck to paycheck, the situation can spiral out of control if you’re not careful.
Therefore, when borrowing money from any source, you must understand that each borrowing option exists for a specific purpose. That’s why you must choose one that suits your needs and overall financial situation.
Take a look at some of the worst and best ways to borrow money.
1. Payday Loans
Also known as a cash advance, this is, by far, the worst way you can borrow money during an emergency. The loan amounts issued by payday lenders rarely go above the $1,000-mark and for good reason.
While the loans are easy to access because these lenders don’t go through your credit history, the interest charged can hit triple digits. In fact, according to the Consumer Financial Protection Bureau, a payday lender is likely to charge $15 for every $100 borrowed.
If you convert this to APR, you’ll arrive at a jaw-dropping 400%. The worst part is you have two weeks to repay the money, or else you’ll face the wrath of debt collectors who’ll use unorthodox methods to get back their money.
2. Pawn Shop Loans
A credit card cash advance is bad, but it doesn’t come close to pawn shops. On the worst ways to borrow money, this method ranks number 2 after payday loans. The main reason why financial advisors warn against it is the high interest rate you’ll have to pay.
Nolo.com puts this interest rate at 240% if you annualize it. As an alternative, instead of using your items as collateral at a pawn shop, why not just sell the items you don’t need?
3. Credit Card Cash Advance
This is probably the most common way many Americans use to borrow money. On the downside, it’s also one of the most expensive options. According to Bankrate, credit card rates are at an all-time high – around 17%. For a credit cash advance, you’ll have to pay more.
A good example is the Chase Freedom card with interest rates ranging from 16.74% to 25.49%, depending on your credit score. For a cash advance, you’ll have to pay a 26.74% APR. Also, you have to factor in the transaction fee that ranges from 3% to 5% of the loan amount.
If it makes the situation any better, credit cash advances are the best among the worst ways to borrow, especially when you’re in a cash crunch. However, financial advisors recommend making purchases with the credit card before paying interest rates as high as 30% or even higher.
4. 401(k) Retirement Plan
According to financial advisors, you should stay away from your 401(k). However, the law allows you to take out a maximum of 50% of the vested balance with the maximum amount being $50,000.
Thereafter, you have up to 5 years to repay the loan. The interest rate offered is lower than other borrowing options such as credit cards. The best part is you’ll be borrowing from yourself and also paying yourself interest.
While this option sounds attractive, there’s a single drawback. Tapping your 401(k) means you’ll miss out on the full benefits this plan offers even if you repay the whole amount plus interest. Also, this step will set you back a few years in retirement savings.
5. Personal Loans
There are two types of personal loan: secured and unsecured. The main difference between the two is the latter doesn’t require any collateral to secure the loan while the former requires it.
Both are great borrowing options, but unsecured loans mean you have to pay more in interest because of the high risk involved to lenders according to nation 21loan, get information here. However, if you don’t have any collateral to put up, you can take out this loan.
Generally, personal loans come with shorter repayment periods – one to five years. Also, it’s unlikely that you’ll miss any payment because it’ll be deducted from your checking account automatically. This will also increase your score in the long run.
These loans are suitable for borrowers looking for small amounts – not over $35,000. They also offer attractive interest rates, with unsecured loans averaging 11%. However, if you have a good credit score, the rate can dip to 5.5%, which is way less than what you’d pay on a credit card.
6. Home Equity
The financial crisis in 2008 changed the lending scene for homeowners after housing prices plummeted, triggering banks and other lending institutions to tighten lending requirements, which hurt borrowers, especially homeowners, when it comes to home equity lines of credit and loans.
Nevertheless, homeowners can still tap a huge amount of equity – in fact, it’s at the highest point ever. Cash-out refinancing is the most common method of tapping into your home’s equity. The idea behind it is to refinance an existing mortgage by taking out an even bigger one and using the excess as a loan.
For a home equity loan, you’ll have access to a huge sum of money and you’ll have 5 to 15 years to repay the loan, which is the same for a home equity line of credit. The only difference is you’ll pay a variable rate for a HELOC, while a home equity loan rate is fixed.
The latter is at 5 to 6 percent, but you must keep in mind, the interest isn’t tax-deductible – not unless, according to new tax laws, the money is for home improvement. Remember, your home will act as collateral and this means you risk foreclosure if you fail to repay the loan.
Now you know which loans to avoid and which to run after thanks to this helpful guide. However, the bottom line is you must understand your financial situation before applying for any loan – even the best one. This will give you a clear picture of whether you can afford it or not.