Borrowing
money is always a last resort, but for anyone who's been in a pinch between
paychecks, sometimes it's a necessary evil. But who or where you choose to
borrow from can take your predicament from a temporary dollar dilemma to a long-term
financial nightmare.
We consulted
financial experts to help decipher which borrowing options are most likely to
set you on a course toward financial disaster. Here are their borrowing
breakdowns, from least risky to last resort...
1. Credit card purchase. Putting
your unexpected expense directly on your credit card is a wiser option than a
cash advance. And, it can actually work to your advantage if you can pay the
balance when the bill arrives, says Beverly Harzog, an independent credit card
expert and consumer advocate. "If you can pay it off and you have a rewards card (or cash back or airline miles), you can get rewards on that purchase as
well."
That
being said, Harzog is quick to point out that any credit card purchase can be a
slippery slope since you can end up carrying the debt for a long period of time
if you're not diligent about paying it off quickly.
The verdict: good borrow... if you pay
off the purchase right away.
2. Pawnshop loan. Believe it or not, a pawnshop loan is one of the better
options to consider, says Mary Hunt, author of "7 Money Rules for Life," and
founder of Debt-Proof Living. "A lot of people think of them as
back alley, but that's really not how they work anymore," she says. In fact,
thanks to shows like "Pawn Stars," they've become more mainstream than ever.
The way it works is you bring in an item as collateral
for the cash they give you. The pawnshop must keep your item for an agreed upon
amount of time (for instance, 90 days). If you come back and pay back the loan
before the term is up, you get your item back. If you don't, your item is sold
The perks: "It's clean. There are usually no credit
checks. And you have the option to not pay it back legally," says Hunt. In
terms of risk, the only thing to consider is how much sentimental value the
item has, just in case you're unable to pay for its safe return.
The verdict: good borrow... if you're
not using your family heirlooms or wedding rings as collateral.
3. Borrow from a relative. If
you're lucky enough to have a well-off relative who's happy to help you out of
a jam, good for you. But even so, when asking for a loan, sit down together and
put the terms in writing, says Hunt. "Have a plan in mind before you plan to
borrow and offer some collateral for that loan. It will put you in a much
better light if you say, 'I want you to hold my iPhone until I pay you back,'"
she says.
Other
terms you need to agree upon include the payment schedule, how much interest
you'll pay (Hunt says 5 percent is a fair amount) and what happens if you miss
payments.
There
are even online services like LoanBack.com and LawDepot.com that allow you to
customize a family loan contract for a small fee. The extra effort may help
avoid a family feud over a few hundred bucks.
The verdict: good borrow... if you
treat your family loan like a business transaction.
4. Peer-to-peer lending. Fairly
new to the lending arena is peer-to-peer lending. Sort of like the eBay of
small loans, a group of lenders pool available funds and then decide which
borrowers they'd like to work with. The SEC is involved, so it's regulated, but
it can be a less strenuous qualifying process than a traditional bank loan.
"Lending
clubs turn down a high majority of borrowers, so it's not a slam dunk. If you
have excellent credit and aren't in debt up to your eyeballs, though, you can
get a good interest rate," says Harzog.
The verdict: good borrow... if you
have good credit and some time to spare until you qualify.
Getting poll results. Please wait...
5. Credit card cash advance. Most credit card companies offer customers the option to
get cash via an ATM or bank withdrawal (sometimes it comes in the form of a
check), but that convenience comes with a price. "First of all, you'll be
charged an initial fee of 3 percent to 5 percent," explains Hunt. "And that
cash amount immediately starts incurring interest." In other words, you don't
have any grace period at all. Perhaps the worst part, however, is that a cash advance is subject to a much higher interest rate than you'd have on a regular credit
card purchase. "It can be 10 percent to 15 percent higher," says Hunt.
The verdict: bad borrow
6. Bank advance direct deposit loan. An advance on
your direct-deposited salary is basically a bank-sanctioned payday loan. You
may feel like it's a legitimate option because your bank is offering cash
upfront for the promise of repayment when you receive your paycheck, but the problem
is the temporary patch can potentially lead to bigger debts down the line, says
Mitchell D. Weiss, a professor of finance at the University of Hartford and
author of, "Life
Happens: A Practical Guide to Personal Finance from College to Career."
"You intend for it to be a one shot deal, but people who can least afford it
get caught in this debt trap," says Weiss.
"You're
sacrificing the future stream of payments for cash upfront today," explains
Weiss. The problem is you won't get all of next week's paycheck, and then what
do you do for an encore if you come up short again?
The verdict: bad borrow
7. Payday loan. Similar to a
bank direct deposit advance, the way a payday loan usually works is you write a
postdated check for the amount you are borrowing with a fee and interest tacked
on, and the establishment gives you the cash on the spot. Another alternative
is to allow the payday lender to electronically transfer the amount from your
bank account to theirs come payday. In other words, you're granting them access
to your bank account, which is always a shady prospect.
"It is like
the ultimate snowball that turns into a huge avalanche. Borrow $100 to start,
and it will turn into thousands," Hunt says. The reason? "They make it sound so
easy." Payday loan providers are often reassuring, says Hunt, telling you not
to worry if you need to roll your loan over for another pay period or until
you're back on your feet. Of course, that means the fees will keep adding on,
too. "They take full advantage of people who don't understand the system," she says.
The verdict: bad borrow
The key to
wise borrowing -- no matter which route you take -- is to first try to avoid it
and if you can't, have a well-thought out plan in place for paying back what
you owe. Try going with the option that will cost you the least in the long
run, and when it's behind you, start socking away some money toward an
emergency fund so you won't have to go borrow in the future.
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