How to Borrow Money Smartly
There are two chief concerns about borrowing money; the first one is: how to borrow quickly? The second one is: how not to get ripped off until payback day?
These are very legitimate questions, but the answers depend on the source you borrow from and the type of loan you get. So, to help you in your decision-making process and empower you to make smart financial decisions, we will take a look at the places that would lend you money, examine the credit products they offer, and rate them accordingly.
But, before we dive in, you deserve to receive a fair warning: there is no such thing as borrowing for free even when you are borrowing from yourself. By the end of this text, you’ll know exactly what we mean by that.
Where to Borrow Money From
Traditionally, banks, credit unions, and similar lending institutions were the authority when it came to obtaining loans. Some of them still are, however, nowadays, there is also a multitude of online lenders that offer alternative options. Finally, those of us that have bad credit are left with getting loans from family and friends, or from pawnshops.
Each of these places for borrowing money has its advantages and disadvantages to be considered.
In essence, there are two types of bank clients: those that leave deposits and those that take loans. The banks pay interest to customers that leave money in their vaults. At the same time, the banks charge interest to customers that borrow money from them. The interest charged to loan-takers is always higher than the interest paid to deposit-makers. This is how banks stay afloat.
Banks offer many credit products (loans paid back with interest) that allow people to achieve important financial goals with their help. They are a traditional lender with a lot of experience in distributing mortgages, business loans, auto loans, and personal loans to those that need them.
You can expect a high level of customer care in a bank. The staff knows their job and you will get assistance with compiling all the necessary documents. Some banks extend perks like financial advice, flexible terms, or discounted rates to loyal customers.
Banks charge additional fees for processing your request. This manifests in origination fees, loan application costs, and servicing fees. Also, banks can change interest rates if the loan is resold to another bank. And finally, banks exist to bring profit to their shareholders, not to protect the wealth of individual borrowers.
Lending from a credit union is accessible only to members. To qualify as a member you must belong to a certain organization or a group; for example, employees in a big company or a tribal community that shares the same ethnic heritage. Since the 2000s, certain credit unions allow outsiders to get loans too, as long as they open an account with them or meet specific eligibility criteria (like place of residence).
The purpose of credit unions is to support their membership and to offer affordable financial services. Their forte is to provide much-needed support to members in times of need (and cut members some slack), which generally translates into good loan terms.
The interest rates of credit union loans are low and their processing fees are either low or non-existent. The loan terms can also be generous and allow for repayment dates that are further down the line.
If you are not a member of a given credit union, it might be hard to become one. You might not be eligible for membership altogether, which means that their favorable offers won’t be accessible to you.
Also, credit unions provide the most straightforward loans (a.k.a. plain vanilla loans), so if you need a more complex credit product, you might have to turn to the big banks.
These days, we can borrow money through the internet and directly from another person. It’s known as peer-to-peer lending (P2P or crowdlending) and cuts the middle man out of the equation. Everyone can apply to borrow money from a peer-to-peer online platform.
Applicants make relevant financial information available to online lenders, while interest rates (and other crucial terms) are extended by investors and approved by both sides. Eliminating institutions ensures the process is streamlined (with pre-qualification in place), but it also leaves risk assessment in the hands of both lenders and borrowers.
If your documentation is in order, your loan can be approved really fast—within a day or two. Online lenders look at the loan as an investment (because they collect the interest directly), so they share your enthusiasm for the whole process. Because of this, you could also get more flexible terms on the loan.
In some cases, your loan can come from multiple sources (more than one lender). The monthly payments for such loans have to go to each of these lenders individually, and this is an unnecessary complication.
Also, keep in mind that there is nothing like free money, so if your online lender doesn’t ask for origination fees, they might ask for high late payment fees or bounced payment fees. Read the fine print on the loan terms.
Borrow From Yourself
Maybe you didn’t see this one coming. It’s an option available to those of you with workplace-based retirement accounts or a 401(k) plan. The IRS has provisions that allow you to either permanently withdraw the cash or take a loan from your account.
Full withdrawal incurs a 10% penalty (for those younger than 59½ years). The loans from a 401(k) account have a limit: $50,000 or up to 50% of the fund (whichever is higher), and you have to repay the loan within 5 years.
Since you are borrowing from yourself, there are no origination fees and missed payments don’t affect your credit score. Interest rates on 401(k) loans are usually low and the interest you pay goes back into your account. If you pay on time there are no taxes and penalties.
You can’t add money to your retirement account until the repayment date of the loan. This is detrimental to your investment in the long run and you can’t afford to miss payments either. If the IRS finds out that you are not making regular payments, you will be charged taxes and penalties because the money loses the status of a loan and becomes a distribution.
Also, in case you stop working for your current employer (who also makes contributions to the same account), you might be asked to repay the loan before the next federal tax return. The worst-case scenario: you lose the retirement nest egg, you pay a 10% penalty (if you are younger than 59½), and you owe taxes on the cash. A grim outlook, so borrowing from yourself is recommended only as a last resort.
Family and Friends
Those of us with bad credit have to be creative in finding a lender. Asking a family member or a close friend to lend a hand while you are in need is a natural course of action and probably the least risky one.
This is also one of the oldest borrowing options out there even though it’s not as diligently documented and possibly escapes the books. Speaking of which, it’s best to follow the laws and regulations on loans when you go for this option despite the fact this lender is your friend. Both you and the lender would benefit from establishing the frequency and method of payment. Put this in writing to avoid issues with the authorities.
The chief advantage of borrowing from people you know is the fact that you can get flexible loan terms. If you aren’t able to meet monthly payments, you can negotiate an extension of your repayment dates as family/friends will have more patience than any institution. Also, these loans beat all of the remaining options if you don’t have good credit (pawnshops and payday loan lenders).
“If you want to lose a friend, loan them money”; have you heard that one before? Failure to repay a loan might destroy the relationship you have with this person, and this is a possibility that you have to keep in mind.
Naturally, the amount of credit you can borrow is also limited by the wealth of the people in your social circle, so sometimes friends and family can’t help you out even if they want to.
These establishments will lend you money without a credit check; they just require an item that would serve as collateral. The amount of money you can get is based on the value of the item you leave at the pawnshop, but in most cases, this is in the hundreds of dollars.
People bring jewelry, electronics, tools, firearms, musical instruments, and sports equipment to the shop—pawnbrokers accept everything they deem to have a resale value. The borrower leaves with a ticket and the loan usually is to be repaid within a month (or several months).
This is a quick way to get a loan. No one goes through your credit history to check your credit score.
You will pay interest on the loan but also costs for appraisal and storage, and there is the risk of your item being estimated less than its actual worth. Also, if you don’t pay the loan on time, you lose the pawned item, and this can be hard to bear if you are emotionally attached to the collateral (e.g. a watch that was in your family for generations).
The specialty of payday lenders are short-term loans, in which the repayment date is within days or weeks. They might look like another online lending option, however, they do have physical stores. Regardless of how bad your credit is, avoid borrowing from payday lenders because although it’s a way to get cash quickly, it’s fairly expensive.
Speaking of which, payday lending is probably the fastest way to borrow (it’s as quick as 15 minutes). The process doesn’t involve a lot of checks. Some lenders ask for basic info like a bank account and proof of your income stream, and that’s it.
You have to respect the short repayment term to the letter. Failing to do so will quickly attract late payment fees that go up as much as 400% of the principal (or the initially borrowed amount). This should be quite literally your last resort.
Now that we have described the most typical creditors out there, let’s examine all the different types of loans they offer.
Such a long list of potential lenders leaves us with a broad spectrum of options for loans. Virtually all of them are credit products (they are paid back with interest), but they do have some differences relative to one another. Some of these loans are unsecured and their terms depend on your credit score, while others can’t be approved without collateral. Also, the interest rates vary and the application procedure is not uniform.
We will focus on personal loans, alternative bank credit products, and credit cards, but also on potentially less known options such as 401(k) loans, high-risk payday, or pawnshop loans.
So, join us as we rate the most common types of credit based on loan terms, the application process, and consequences in case you default on the loan.
Borrowers with good or excellent credit generally get the lowest rates and best terms for a personal loan. Such loans are preferred because most of the terms are fixed (including interest rate, monthly payments, and repayment timeline).
You might want to shop around, though, to find whether your best option is to take it from a bank, a credit union, or an online lender. Let’s take a look at their terms.
From a Bank
- Origination fee: usually there is one (1–10% of the loan), and if not, take a look at the service fees.
- Interest rate: not higher than 20%, and terms might include a fixed interest rate, fixed monthly payments, and a fixed repayment timeline.
- Availability: the application process lasts several business days and requires supporting documents.
- Eligibility: good credit is crucial for getting favorable loan terms, however, even people with bad credit can get an unsecured loan at a higher interest rate with high origination fees or a mandatory co-signer.
- If you default on the loan: your debt is sent to a collection agency and your credit score goes down.
From a Credit Union
- Origination fee: non-existent or very low.
- Interest rate: less than 20%, usually lower than interest rates on bank loans, and you can get an extended repayment schedule.
- Availability: several business days; similar to banks.
- Eligibility: accessible to borrowers with fair credit score (FICO score 610 to 640).
- If you default on the loan: it’s unsecured lending, so your debt is sent to a collection agency and your credit score goes down.
From Online Lenders (P2P)
- Origination fee: it might come without an application fee, but double-check other terms (late payment).
- Interest rate: usually below 20%, but some lenders might offer flexible repayment terms.
- Availability: one business day (sometimes more than that).
- Eligibility: it depends, but generally accessible to borrowers with a fair credit score (FICO score 610 to 640).
- If you default on the loan: the same as above—the debt is sent to a collection agency.
Other Credit Products From Banks
Personal loans aren’t the only option to borrow from a bank.
One alternative is to make the most of your credit cards by using promotions and cash advances. Credit cards are predominantly used for amounts that are lower than personal loans. The other alternative is to go for a personal line of credit (PLOC) or home equity loans and home equity lines of credit (HELOC), provided you satisfy the conditions to apply.
Let’s check them all out in greater detail.
Loans on Credit Cards
If you need up to $5,000, taking a new 0% APR credit card or asking for a cash advance on your existing credit card might put you out of financial straits. In essence, you are benefiting from the grace period (up to 18 months) extended to new clients; there is no interest on the borrowed sum during this time. And when you need a loan in the hundreds of dollars, you can withdraw cash advance from your credit card.
0% APR credit card
- Origination fee: 3% to 5% of the total amount.
- Interest rate: no interest (double-check the terms to determine how long your promotion period lasts).
- Availability: up to ten business days.
- Eligibility: good or excellent credit score (690 or above on the FICO scale).
- If you default on the loan: if you miss payments, interest kicks in (regular APR – up to 30%), and if you default, your credit score goes down.
Cash Advance on a Credit Card
- Origination fee: ATM fees.
- Interest rate: high (up to 30%); additional fees might apply.
- Availability: immediately (if you already have a credit card).
- Eligibility: tailored to your credit score and the card’s cash advance limit.
- If you default on the loan: your credit score is reduced.
Lines of Credit
A personal line of credit (PLOC) holds the middle ground between a credit card and a personal loan. It’s unsecured lending, meaning your credit score determines whether you are eligible for credit. On the other hand, home equity loans and home equity lines of credit (HELOC) are types of loans that extend beyond the range of personal loans (at least in the tens of thousands) and you are practically using your home as collateral.
- Origination fee: bank fees.
- Interest rate: up to 20%; late payment attracts additional fees but allows flexible use of funds.
- Availability: several business days.
- Eligibility: good or excellent credit score (above 690 on the FICO scale).
- If you default on the loan: your credit score is reduced.
- Origination fee: 2% to 5% of the loan amount.
- Interest rate: around 5%; you can draw funds as needed and interest applies only to the used amount.
- Availability: up to four weeks.
- Eligibility: credit score of at least 620; your property is collateral.
- If you default on the loan: foreclosure of your property.
Borrowing With Bad Credit
Truth be told, borrowing options are more limited if you have bad credit, but this doesn’t automatically translate into not having access to loans. Once you put some effort into studying the offers, you will see that few of them actually work, while the rest are to be avoided at all costs.
The most popular options are to take out loans from your retirement accounts, like 401(k), borrowing from friends, or taking a payday or pawnshop loan.
Let’s consider these options.
- Origination fee: less than $100.
- Interest rate: a point or two above prime rate (less than 10%) and you are paying the interest to yourself.
- Availability: up to ten business days.
- Eligibility: having a 401(k) account; there are no credit checks, but you are putting your retirement fund as collateral.
- If you default on the loan: you lose the retirement account, pay penalties (10%), and may even owe taxes.
Loan From Family and Friends
- Origination fee: none.
- Interest rate: flexible general terms, as long as you are able to negotiate them.
- Availability: depends on the creditor; sometimes right away.
- Eligibility: no credit report check or more favorable conditions.
- If you default on the loan: you put a close relationship at risk.
The last two options are a quick source of money, but also a problematic one. Payday loans are up to $500 and the repayment date is within weeks, so this is a super short-term loan. Pawnshop loans may have longer repayment periods, but usually don’t allow borrowers to take more than 70% of the value of the pawned item.
- Origination fee: none, but you are charged for storage and appraisal.
- Interest rate: 10%–200% if there is no state law restriction on interest; late payment attracts excessive fees.
- Availability: same day.
- Eligibility: no credit report check, but you leave a valuable item as collateral.
- If you default on the loan: the pawned item is sold to someone else.
- Origination fee: 10% of the loan.
- Interest rate: the APR is as high as 400% and late payment might attract service fees that are higher than the borrowed sum.
- Availability: within as little as 15 minutes.
- Eligibility: no credit report check, but you have to respect repayment terms.
- If you default on the loan: the debt is sold to a collection agency and penalties apply.
Tips on Borrowing Money
Financial decisions should be supported by a level-headed thought process regardless of how badly you need fast cash. At one point or another, every single one of us would like to have money available instantly, but this doesn’t mean that you should take the first offer you come across (unless it actually turns out to be a good one after you compare it to others).
There are three phases in this process: exploring your options, devising a payback plan, and execution.
Exploring Borrowing Options
Since you are still reading this text, you are probably in the exploring phase. And before you landed here, you did your best to identify your need for a loan. If that’s not the case, do it as soon as possible and in the strictest terms. Why is this important? Because each borrowing option has its strengths; some offers are good for small amounts of cash, while others have good repayment terms, or are available on fairly short notice. If you know what you need, you will come to a better decision.
We are all looking for the best ways to borrow money. Avoid the pitfall of comparing only one of the loan terms (e.g. interest rate) when you look at different offers. Credit products have an underlying insidious quality of coming to bite you with an extra fee when you least expect it. Make sure your analysis is comprehensive and take into account many variables (interest rates, loan fees, loan repayment timelines, etc).
The monthly payments (or similar installments) have to be paid on time. Complying to loan terms often saves you from a lot of headaches, so devise a detailed payback plan before you accept the obligation. Such plans boil down to efficient budgeting.
It’s recommended (conventional wisdom) to ensure that at least 20% of your earnings can be used for debt repayment. You need to make an assessment of your long-term monthly budget based on current income and expenses. Obviously, predicting future changes is also relevant because getting an inheritance or losing a job would quickly transform your financial outlook.
If you are not comfortable doing (or adhering to) your budget, you could use some help from software or advice from professionals. When the numbers don’t add up, you can reconsider eliminating non-essential expenses.
Always consider the worst-case scenario. If you don’t repay the loan, you’ve got to have a fallback position that is better than losing an asset, the reduction of credit score, or a lost relationship.
This one is easy—you go and take the loan. Actually, there are a thing or two you need to monitor once you get the money. First, you need to stay vigilant for refinancing opportunities. In plain terms, this means to be on the lookout for a drop in interest rates. If that happens, you can refinance the loan and pay less interest in the long run.
Also, don’t rush into repaying the debt before the due date. When you have enough money to cover your debt, use them for something else because many banks charge fees for premature settlement of loans.